TimesOnline's Anatole Kaletsky: Why the buck will rebound

Why the buck will rebound
Anatole Kaletsky
TimesOnline

The dollar's collapse has all the characteristics of a financial speculation reaching its climax

IN THE past week, the value of the pound has risen to almost $2, the first time that sterling has been anywhere near this level since just before Black Wednesday in September 1992. The euro has been hitting record highs against the dollar almost daily. And everyone from Alan Greenspan, the Chairman of the Federal Reserve Board, to the humblest foreign exchange clerk, seems convinced that the dollar is bound to keep falling.

Does this mean that British businesses and investors should prepare themselves for a pound worth more than $2, a level never breached since 1981? Or is this a once-in-a-lifetime opportunity for British savers to buy dollars at a bargain price?

Economists who want to protect their academic reputations are usually careful to avoid financial predictions. This is especially true of currency movements, which are considered impossible to forecast. Fortunately, journalists do not have reputations to protect and need not be bound by this convention. Thus, the cover story of this week’s Economist magazine has the headline “The Disappearing Dollar”. It bravely predicts that devaluation of the dollar from its present level is “inevitable” and suggests the possibility of a further 30 per cent fall. I take the opposite view. In my opinion, the dollar has now reached a level from which it can only rise, at least against the euro and pound.

Anyone who buys dollars at the present exchange rate may suffer some sleepless nights in the short term, since pure momentum could continue to drive the dollar downwards for another month or two. But looking slightly further ahead (and don’t ask me to be too specific about the timing), it will seem incredible that £1 could be worth $2, just as it is now incredible that companies such as AOL, Amazon and Yahoo! were once worth the hundreds of millions of dollars which investors paid for them in late 1999.

The rise of the pound to almost $2 has been driven entirely by bearish views on the dollar, rather than any particular enthusiasm for sterling. British currency investors should focus on the relationship between the dollar and the euro, rather than the virtues or otherwise of the pound, for once the dollar recovers against the euro, it will also rise against sterling.

In the past few weeks, the dollar’s collapse against the euro has acquired all the characteristics of a financial speculation reaching its climax. That so many experts are so completely convinced of the market’s direction is a classic sign of this. At some point, the policy mistakes and economic imbalances which have driven the dollar downwards will start to be corrected — and that point is probably not far off. The most important of these imbalances is not the US trade deficit or budget deficit, but the weakness of consumption and employment in the eurozone.

A falling currency can be dangerous and unpleasant for a country that is threatened by inflation, but because of intense competition and plenty of surplus labour, America is unlikely to face any serious inflation, at least for the next year or two. Thus the US has no reason to worry about the declining dollar, still less to change its policies.

But America’s trading partners, especially Europe, face a very different prospect. The falling dollar makes American goods cheaper in world markets. It helps to boost US export industries at the expense of industries in Europe, Britain, Japan and the rest of the world. But Europe suffers far more than other exporting economies for two reasons.

First, Europe, and especially Germany, are currently much weaker and more dependent on exports than other economies such as Britain. Secondly, most exporting countries outside Europe link their currencies either formally or unofficially to the dollar. Asian countries are prepared to intervene forcefully in the markets to stop their currencies from getting too uncompetitive — and they have done this to the tune of almost $1,000 billion during the past three years.

The Europeans, by contrast, have followed a dogmatically free-market approach to currency management — bizarrely so, given that the weaknesses of the European economies are mainly due to the rejection of free-market policies in domestic economic management. Thus when the dollar goes down against the euro, so do the Chinese renmimbi, the Korean won and the Japanese yen.

The declining dollar therefore exposes Europe to a devastating pincer movement. At the top end of the market — technology, high-end services, luxury goods and so on — European exporters lose global markets to American and Japanese competitors. At the bottom end, ever cheaper Chinese and Korean exports destroy the low-cost, labour-intensive industries which still provide millions of Europeans with jobs.

If the dollar continues to fall against the euro or even remains near its present level for more than a few weeks, the European Central Bank will face intense pressure to reduce interest rates. If it does so, Europe will have its first serious chance of economic recovery since 1999. And a European recovery would reduce the US trade deficit, underpin the dollar and allow an orderly decline of the euro to a reasonable, competitive rate.

But what if Europe’s central bankers refuse to respond to the dollar’s weakness by easing monetary policy? The market will then do the job for them. This process has already begun. By pushing the euro even higher against the dollar, currency speculators will extinguish all remaining hope of a European economic recovery. As Europe slides into recession, the ECB will be forced to cut interest rates for purely internal reasons. This easing may come too late to revive the European economy, but it will certainly trigger a euro collapse. Either way, the euro will fall, the dollar will recover and, in the process, the pound’s value against the dollar will move back to more reasonable levels. The days of the two-dollar pound are numbered.

Buttonwood of the Economist: The case for Asia

The case for Asia
Dec 7th 2004 From The Economist Global Agenda
Foreign investors have been pouring money into Asian shares. For once, their bets may pay off

TO THE probable surprise of those who think of this column merely as a font of scepticism, there are indeed a few markets for which Buttonwood holds a warm affection. Take Asian stockmarkets. To the surprise of almost everyone (including your columnist), most of them have actually gone up lately. True, Japan has wobbled a bit in recent months, but the Nikkei aside, Asian markets have generally recovered strongly since the sell-off in April and, according to a widely watched index from Morgan Stanley, this week reached a four-year high. A few of the more exotic destinations—Karachi is one—have never been higher.

The region has been a magnet for foreign money, especially American money, attracted by cheap stocks and heady growth—since 2000, emerging economies have grown two and a half times faster than rich ones—and deterred from investing at home by meagre bond yields and over-generous share valuations. Flows into American mutual funds specialising in international equities have jumped, according to EmergingPortfolio.com. So far this year, some $67 billion more has been invested in these funds. And an increasing proportion of it has been popped into emerging markets. Flows into both international funds and dedicated emerging-market funds jumped sharply in November.

The Institute of International Finance expects Asia to attract almost half of all private capital going to emerging markets this year, though it expects its share to be below last year’s. Although portfolio flows fell sharply in April, when many investors fled, they have picked up smartly in recent weeks. Money invested in Japan funds has risen by 57% so far this year and, until recently at least, international investors were mostly bullish on the prospects for Japanese shares.

The contrarian in Buttonwood would take this as reason to sell. But just because investors are wading into Asia does not necessarily make it wrong. The problems of the American economy, and by extension its stockmarket, are all too well known. Clearly, investors are underwhelmed by such arguments, for the American stockmarket still accounts for just over half of the world’s stockmarket capitalisation. In contrast, Japan accounts for 9%, and the rest of Asia just 3.5%. But even if you think that Japan is long past its sell-by date, the region includes the fastest-growing economies on the planet, and the most populous: Asia, after all, is home to 3.8 billion people.

About 1.3 billion of these are, of course, in China, which also happens directly to have accounted for about a quarter of world growth over the past three years, measured in terms of purchasing-power parity, and a good deal more indirectly, given how much Chinese imports have fuelled activity elsewhere in Asia. Japanese exports to China are growing by anything up to 40% a year; its exports to America, in contrast, are shrinking. Intra-Asian trade is growing by leaps and bounds.

This raises four big questions. The first is: to what extent is Asia’s growth rigged by exports subsidised by cheap currencies? Quite a lot, is the short answer. As Bank Credit Analyst, a research firm, points out, since 1992 emerging Asia's exports have grown 80% faster than consumption. Lack of consumption, lots of savings and currencies quasi-pegged to the dollar—in China’s case, fixed—have resulted in huge current-account surpluses and rapidly mounting foreign-exchange reserves. Asia’s central banks have been recycling these into US Treasury bonds.

Of late, many of these countries, with the exception of China, have let their currencies rise against the dollar, perhaps for fear of an altogether sharper and more unpleasant adjustment down the road. The yen has risen especially fast. Of course, rising currencies raise questions about whether heady growth rates will be sustainable; shares in exporters have suffered somewhat. It is hard to say how much further Asian currencies will rise, how much it will affect exports, or how long it will take for consumption to take up the slack.

Which brings up the second big question: how much will Asian growth benefit investors? A big reason why emerging economies have not emerged is that property rights are generally someone else’s. And this is doubly true if you are a foreign investor. Just ask any investor in China, which continues to account for the bulk of foreign direct investment in Asia. Still, domestic plays, though risky, are not without reward. Banks in Japan, a country where outside investors are treated shoddily, are, in essence, a purely domestic play. Although there was a sharp sell-off in April, shares in Japanese banks are some three times higher than at their low in the spring of 2003, and the rise has picked up pace in recent weeks.

The third question concerns the sustainability of Chinese growth. The country’s investment boom was hugely helpful in pulling the rest of Asia out of its slump in 2001. Were it to falter, so the rest of Asia would stumble; and, for all its size, Japan would not be immune to such a shock. Still, though investors were fearful earlier in the year that giddy growth would lead to a hard landing, the signs are that, while China is slowing somewhat, it is not headed for a fall. Inflation shows signs of dropping, and the central bank may need to do little more than it has already done to cool the economy.

The final question is about American markets. Were these to tumble, appetite for risk would fall sharply, and Asian markets would suffer as much as those anywhere—probably more so, given their illiquidity and the extent to which they have been propelled upwards by foreign money.

Still, that would seem to be as good a chance as any to buy. And at least investors are somewhat protected by valuations. For all their recent rise, Asian shares are still almost 40% below their 1994 peak. The cheapest market in the region, South Korea, trades on a price-earnings ratio of seven, less than half that of American shares. At the height of its stockmarket bubble, Japan accounted for the same proportion of the world’s stockmarket capitalisation as America does today. Now you can buy the whole of Asia for a quarter of that.

Stuff.co.nz/Reuters: Papua New Guinea chasing world commodities boom

Papua New Guinea chasing world commodities boom
TUESDAY , 07 DECEMBER 2004

SYDNEY: Impoverished Papua New Guinea is racing to overhaul its foreign investment laws to cash in on a world boom in commodities prices, a senior PNG minister said yesterday.

Gold, oil, copper and other mineral commodities found in abundance in the South Pacific nation are selling for the highest prices in decades on world markets, setting in motion a global exploration boom.

The country may miss a "window of opportunity" due to political instability and a lack of much-needed public and private sector reforms that were keeping foreign investment away, PNG's minister for mines, Moi Avei, told a gathering of miners and investors.

"PNG has a real opportunity to capitalise on the boom in commodities," said Avei, who gave the address, filling in for PNG Prime Minister Michael Somare who was ill.

"However, there is lingering doubt in the marketplace (about its ability). Avei said. "It's been going on for years."

Plans to lay a 3000-km pipeline under the Coral Sea to connect eastern Australia with the remote gasfields of the PNG Highlands and inject up to $US285 million a year into the domestic economy are still under review by ExxonMobil Corp, more than two years after Somare made the project a national priority.

The last big gold discovery was nearly a quarter-century ago on Lihir Island. More recently, the world's biggest mining company, BHP Billiton Ltd, relinquished its stake in the OK Tedi copper mine on environmental grounds.

Mining accounts for about a third of PNG's gross domestic product (GDP), though this contribution is more than washed out by national debt, which this year will account for 55 per cent of GDP, down from 75 per cent of GDP last year.

Hoping to rope in more investment in mining, PNG is abolishing a 2 per cent levy on imported goods – most mining equipment is shipped in as PNG has little domestic manufacturing – and extending foreigners' work visas to 10 years from two.

"The minerals and energy sector is certainly our lifeline," Avei said.

But even if PNG becomes more friendly to the mining industry, other problems persist.

For years, successive governments have failed to combat growing HIV infections, street crime and poverty. More than 200 Australian police have been dispatched to help an understaffed local force patrol PNG's most crime-plagued ditricts.

"Inefficiency in the public sector has become entrenched," Avei said.

PNG's Treasuer Bart Philemon told the conference the government was completing its 2005 budget amid signs the country's coffers were improving.

The national currency, the kina, was stablising, inflation was going down and economic growth was nearing 3 per cent, he said.

PNG is made up of 600 islands, where 85 per cent of its 5.3 million people live subsistence lives in villages clinging to jungle-clad mountains. It is divided by 850 languages, where tribal allegiances dominate and tribes engage in bloody wars.

Bloomberg: Newmont Says Legal Wrangle Won't Deter Indonesian Investment

Newmont Says Legal Wrangle Won't Deter Indonesian Investment

Dec. 5 (Bloomberg) -- Newmont Mining Corp.'s legal dispute with Indonesia over alleged pollution won't deter the world's biggest gold miner from investing $85 million in the nation next year, said Chief Executive Wayne W. Murdy.

``This is a nation that has huge potential from a geologic standpoint'' Murdy, 60, told reporters in Jakarta yesterday after meeting government officials on his four-day visit. ``It has a lot of mineral wealth, and it's a place we want to do business and make a long-term commitment.''

Indonesian Environment Minister Rachmat Witoelar on Nov. 25 said the government would sue the Denver-based company, citing a report that said dumping of waste from its Minahasa mine in North Sulawei province caused arsenic levels in a nearby seabed to rise to 10 times the levels allowed in the U.S.

``It's shocking thing to see these allegations,'' Murdy said. ``Some of these allegations... I don't know what the intent is.'' He said it's the first time Newmont has faced criminal charges in any country.

The dispute comes as Indonesia is trying to boost investment from overseas. Mining investment in 2003 declined for a sixth year, a drop companies operating in Indonesia blamed on conflicting regional and national laws and on illegal mining. Third-quarter production of gold, copper, nickel, aluminum and other precious metals fell 6 percent from a year earlier.

High-Level Talks

Murdy, who left yesterday, met Indonesian Coordinating Minister for Economic Affairs Aburizal Bakrie and Mines and Energy Resources Minister Purnomo Yusgiantoro during his visit.

Indonesia accounts for 30 percent of Newmont's net income, Murdy said. More than $2 billion has been invested in the company's operations there since 1985. About $735 million was directly invested by Newmont company and the balance by partners that include Sumitomo Corp. of Japan, he said.

Newmont's only working mine in Indonesia now is in Batu Hijau in West Sumbawa province, where 7,000 workers excavate copper and gold. The mine has resources to ensure production up to 2033, said Robert Gallagher, vice president for Newmont Indonesia.

Most of the company's 2005 investment will go toward development of the mine. Newmont invested about $20 million last year on exploration in Indonesia.

``We look long and hard before we go into a new country,'' he said. ``One of our strategies is to operate in relatively few places, in very large mines that can have very long lives because you can train the workforce.''

Villager Complaints

The Minahasa mine at the center of the legal dispute closed in August after gold reserves were depleted. It started operation in March 1996 with an investment of $135 million.

Villagers living near the mine complained to police about five months ago that they were suffering health problems after eating fish from nearby Buyat Bay. Newmont has said its waste- disposal processes are in line with legal limits. Police earlier detained and released five Newmont executives before formal charges were filed.

Bakrie gave assurances the company will get a fair hearing, Murdy said. Lawyers estimate the case may drag on for up to three years if the dispute goes all the way to the Supreme Court.

``We have a government that's just been elected and that's been very, very vocal about dealing with corruption,'' Murdy said of Indonesia. ``This case has gotten a lot of notoriety.''

In the quarter ended Sept. 30, Newmont's net income rose 12 percent to $128.7 million, or 29 cents a share, as revenue rose 32 percent to $1.16 billion. The company's shares closed up 51 cents, or 1.1 percent, at $46.38 in New York trading on Dec. 3.

http://quote.bloomberg.com/apps/news?pid=10000006&sid=aFEciTsHj6AY&refer=home

China Daily News: New wave of gold rush hits China

New wave of gold rush hits China
By Liu Jie (China Daily)
Updated: 2004-12-02 10:13

The gold rush is reaching a feverish pitch in major cities across China.

In a Beijing store, 300 kilograms of gold bars minted by the China Gold Coin Inc to commemorate the Year of the Rooster, going for a retail price of 125 yuan (US$15.60) a gram, were sold out within seven hours on November 19.

To avoid a stampede for the precious metal, the store, Beijing Caishikou Department Store, arranged the sale of the second batch of gold bars on November 26 through a telephone hotline rather than over its counters. Although the price for each gram of a bar has increased to 128 yuan (US$15.42) this time, demand exceeded supply by a big margin, according to Wang Chunli, the store's general manager.

Gold, as a symbol not only of wealth but also of good fortune, has always had a special place in the hearts and minds of the Chinese people.

Other than tradition, the latest round of the gold rush has been fuelled by a combination of factors, including the depreciation of the US dollar, the world's major reserve currency; and the surge in prices of a wide range of commodities, including oil, otherwise known as black gold.

Unsurprisingly, China's 300 or so gold producers are smiling all the way to the bank.

Their combined profits for the first three quarters of 2004 jumped 35 per cent from a year earlier to more than 2 billion yuan (US$240 million). China's gold production during those three quarters increased 7 per cent from a year earlier to 149 tons, while demand is expected to increase to 220 tons in 2004 from 207 tons in 2003.

The strong demand for the yellow metal has not gone unnoticed by the nation's banks and other financial institutions, which are gearing up to cash in on the boom.

For instance, Bank of China's Shanghai branch, in November introduced "Gold Treasure," a gold-based investment instrument operated by the People's Bank of China, the central bank.

"Gold Treasure" has been designed to make it convenient for the public to invest in the precious metal. Instead of taking physical delivery of the gold, the investor is given a document issued by the bank certifying the amount purchased. The investor can sell the gold back to the bank and surrender the certificate.

A central bank source says that trading in "Gold Treasure" has been increasing by more than 40 per cent in volume per month this year. Demand has consistently exceeded supply by a wide margin, the source said.

Investors who take pleasure in counting gold they have can opt for the CGS bullion bars that come in three weights: two, five and 10 ounces.

They all come in one purity standard: 99.99 per cent. Minted by CGS Limited, a joint venture between mainland and Hong Kong bullion traders, CGS Standard Gold Bars have become a favourite of China's gold investors since they were introduced to the market in July.

Pricing of the CGS bars is based on the daily gold price on the London Precious Metal Exchange with the quotations on the Shanghai Gold Exchange serving as a reference.

Sales agents for the CGS gold bars say that demand from investors has been rising. What's more, buyers are holding onto their gold expecting further increases in the price, the agents say.
For example, figures released by China Merchants Bank show that sales of CGS gold bars at its Beijing branch amounted to 180 kilograms in the period from July 12 to November 15, while repurchase of the bars previously sold totalled only 15 kilograms.

An executive of the bank's branch figures investors in CGS gold bars have, on average, made a gain of around 5 per cent.

"But still, few investors are willing to take the profit at this time because of the continuous strong up trend (of the price of gold)," he says.

Like thousands of investors, Long Jing, a middle-aged executive of a foreign-funded enterprise in Beijing, bought 2.5 kilograms of CGS gold bars on July 23 at 105.2 yuan (US$12.67) a gram.

But unlike most others, she sold the gold back to the bank in mid-August when the price went up to 117.26 yuan (US$14.13) per gram and pocketed a total profit of 37,000 yuan (US$4,458), excluding commissions and other charges.

Describing herself as a "proactive" investor, Long says she was back in the game in October buying 3 kilograms of gold bars. "I am watching the market very closely for the best time to sell," she says.

Banks are also getting into the game in a big way. China Merchants Bank, for instance, has applied to the China Banking Regulatory Commission for permission to provide an on-line gold trading service to its customers and allow customers to use the gold they own as collateral to secure loans.

CGS is understood to have made a similar application to the bank supervisory agency.

A recent questionnaire by the Beijing Gold Economic Development Research Centre in 10 major cities in China showed 70 per cent of respondents said they would invest in the gold trade if they had the money.

More than 20 per cent of securities investors would transfer part of their capital to gold trade considering the gloomy stock and securities markets on the Chinese mainland.

While the average punters have been hit by gold fever, the professionals on the Shanghai Gold Exchange are keeping their cool.

After a 40 per cent surge in the first 10 months of this year, trading began to level off.

"We are seeing a cooling-down in activity as traders become increasingly cautious," says an exchange manager.

"The big price jump in the past several months has many traders worried about an impending correction which could be equally dramatic," he says.

In the face of the continuing price surge, experts and insiders hold various views about the trend of the market.

Paul Walker, CEO of GFMS Ltd, the London-based precious metals consultancy, says "a slump in the dollar and a surge in (gold) investment is likely to continue.

Walker made the comment at an international forum on global gold outlook, infrastructure support and market development held on Monday in Beijing.

An analysis report, conducted by ANZ (Australia and New Zealand Banking Group Limited), indicates the gold price is expected to exceed US$500 per ounce.

The report said the double deficit surge in the United States, which could not be offset in a short period of time, might drag the US dollar further down, stimulating gold to climb to a new record.
However, Liu Shan'en, an analyst at Beijing Gold Economics Research Centre, describes the current bullion price as "incredible."

He says the market is reaching the apex of the up-cycle. "I expect that it (bullion price) will return to a more rational level anytime soon," he says.

Japan Times Editorial: Asia takes a historic step

Asia takes a historic step

Historians may well look back at this week's summit of the 10-member Association of Southeast Asian Nations and call it the first real move toward creating a regional economic group that unites all of Asia. It pushed the political agenda forward as well, signaling a shift in the ASEAN-Plus-Three (Japan, China and South Korea) get-together that follows the summit, and inaugurated new relations with ASEAN's other dialogue partners.

The organization's unwillingness, however, to fully confront problems among its members, most notably in Myanmar and Thailand, is a reminder that ASEAN's operating principles may yet undermine its ambitious plans.

The highlight of this week's meeting was the signing of a China-ASEAN trade accord that calls for the elimination of tariffs on a range of agricultural and industrial goods by 2010 -- the first concrete step toward the China-ASEAN free-trade agreement (FTA). The limits of the deal -- the absence of a dispute settlement or an enforcement mechanism, as well as the restrictions on goods and the omission of services -- means that all will depend on the implementation of its provisions. Historically, that is a problem: Despite previous trade deals, nontariff barriers continue to plague regional economic relations.

Nevertheless, the trade accord consolidates China's position as the nation leading Asian economic cooperation and development. Beijing's signing of a declaration on a code of conduct within the region is another important step that helps diffuse concern about China's long-term intentions.

Just as important is the impetus the deal gives ASEAN to accelerate its own plans for integration. ASEAN leaders agreed to move up by three years -- to 2007 -- the deadline for eliminating tariffs on intra-ASEAN trade in 11 major product groups. It is estimated that these cuts will affect one-third of the $720 billion in trade among the group's members. Eliminating barriers among ASEAN nations is crucial if Southeast Asia is to stay competitive with China. Without those tariff cuts, trade will increasingly move between individual nations to China. Creating a free market within ASEAN will spur trade within the region, and the region's own growth.

Conscious of the region's growing reliance on the Chinese market, ASEAN has been reaching out to other dialogue partners too. At this week's meeting, the prime ministers of Australia and New Zealand made historic appearances, even though hopes for a leap in relations with Australia were dampened by Canberra's refusal to join ASEAN's Treaty of Amity and Cooperation. The group also signed a partnership agreement with India, which could boost trade between the two from the current $13 billion to $30 billion by 2007.

Japan was another winner at the meeting. Japan and ASEAN issued a joint statement calling for negotiations on a comprehensive economic partnership to begin next April and conclude within two years. This partnership should result in a FTA by 2012. In another statement, the two restated their resolve to prevent and fight terrorism. ASEAN also endorsed Japan's bid for a permanent seat on the U.N. Security Council.

ASEAN has now agreed to conclude FTAs with all three of its Northeast Asian trade partners, although each has a different target date. These trade deals are designed to create a trade bloc that rivals the European Union and North American FTA. They will provide a huge boost to the region's economic prospects, spurring growth and sharing prosperity. ASEAN's efforts to diversify its trade relationships also serve a strategic purpose: They ensure that Southeast Asia is not excessively reliant on China. Japan, India, and Australia and New Zealand all provide strategic counterweights to China.

This balancing act also allows ASEAN to maintain the initiative in its relations with other nations. Ultimately the success of that effort depends on ASEAN's ability to remain unified and to act when needed. Unfortunately, those two imperatives can clash, as was evident in this week's meeting. ASEAN's reluctance to interfere in the domestic politics of its member nations -- in this case, Myanmar's standoff with a prodemocracy opposition and Thailand's approach to the violence in the south -- makes it look weak and ineffectual, and it alienates other governments with which it must work. ASEAN is overcoming this aversion to such moves, although at a glacial pace.

ASEAN's readiness to tackle those problems is essential if the organization is to take its place on the global stage. ASEAN's success will provide the foundation of Asia's own rise as a political power to rival the Americas or Europe. This week's summit makes that future possible; ASEAN's actions can make it happen.

The Japan Times: Dec. 4, 2004

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Daniel Lian of Morgan Stanley: Navigating Long Macro Voyage for Southeast Asia

Navigating Long Macro Voyage for Southeast Asia
Daniel Lian (Singapore)

Morgan Stanley

Navigating Southeast Asia’s Structural Investment Themes and Avoiding Cyclical Noise and Rhetoric

International investors are clearly excited about the prospects for Southeast Asia, especially Singapore, Malaysia, Indonesia, and the Philippines. All sorts of cyclical and structural reasons are being advocated to justify reweighting of the region. Last week, we highlighted to investors that despite an improved macro environment, a favorable shift in economic restructuring strategy, and momentum in political economy reform, Southeast Asia remains quite heterogeneous. Different Southeast Asian countries have made different degrees of progress in each of the positive areas highlighted by international investors.

Favorable cyclical factors are often fickle. We believe Southeast Asia must navigate a long macro voyage. On this voyage, investors must carefully analyze and appraise structural developments, and eliminate unsustainable cyclical noise and rhetoric. Last week, we began our voyage by discussing the common favorable factors cited by international investors, on a country-by-country basis, and analyzing their merits and demerits (Macro Cherry-Picking Southeast Asia, November 24, 2004). This week, we examine the “investment theses” advocated by various quarters of the investment community.

Political-Economy Reform and Domestic Security — Geopolitical Risks

A large number of international investors are clearly excited by the prospect of political economy reform and the probability of some containment of domestic security and geopolitical risk. The emergence of new leaders (Malaysia and Indonesia) and stronger mandates on second terms (in the Philippines and possibly Thailand) are key factors in such excitement.

We do share the excitement to some degree. There are clearly some prospects of political economy reform concentrating on elimination of or substantial reduction in the rent-seeking complex (Malaysia, Indonesia, the Philippines) that, in turn, would substantially improve the distribution of economic fruits and the multiplier impact on growth, as well as probably reduce domestic security and geopolitical risk (Thailand, Indonesia, the Philippines). However, both efforts require a favorable political climate where the politicians who drive the present reform stay in power. One cannot rule out probable “offenses” and “responses” by vested interest groups and local separatist or extremist elements where they will fight to retain their rents and their goals. It is probably fair to price in some positive development, but, in our view, the market risks substantial mispricing on both. For example, over the past year or so, the market has been fairly optimistic on Malaysia, Indonesia, and the Philippines, but pessimistic and punitive on Thailand. It remains somewhat uncertain whether investors are correctly pricing the risk premium linked to political-economy reform and domestic security in Southeast Asia.

The “Natural Complementary Economic Relationship” with China

One of the strongest reasons that investors cite for investing in Southeast Asia is that the four bigger Southeast Asian countries (Malaysia, Thailand, Indonesia, and the Philippines) are well positioned to continue “exploiting” the “natural complementary economic relationship” — China manufactures for the world, and Southeast Asia supplies agriculture and resources to China as its manufacturing dwindles with the rise of China.

We have been strongly advocating the deployment of a dual-track strategy to develop the vast but underdeveloped non-manufacturing second-track sectors. Our argument is that this would reduce Southeast Asia’s dependence on manufacturing, multinational corporations, and their foreign direct investment. Pricing power would be improved by securing economic niches not “threatened” by China. Nonetheless, I am skeptical that the region is now fully ready to effectively exploit the complementary relationship opportunity with China.

There is indeed an elementary complementary economic relationship between China and Southeast Asia. China is single-mindedly pursuing industrialization, whereas Southeast Asia has the endowments and the development niche to be an even bigger agriculture, agro-business, tourism, and other soft-hard commodity supplier to China. However, the Southeast Asia niche in this aspect is relatively underdeveloped. Without proactive development of such a basic complementary niche through comprehensive economic strategy shifts, Southeast Asian nations cannot expect to make a good living out of the basic complementary economic relationship. We believe that a well thought out “dual-track strategy” emphasizing the development of the “second-track” sectors — agriculture, agro-business, rural and grassroots, small and medium enterprises, resources encompassing both soft and hard commodity development — and complementing the “first track” that emphasizes only mass manufacturing and urban-centric service infrastructure development is a critical strategy shift required by Southeast Asia in order to prosper together with China.

However, Southeast Asia ex-Singapore is far from fully exploiting its second-track potential. The whole region has become more manufacturing-dependent, in terms of both output and exports, over the past decade. Manufacturing output’s share of ASEAN 5 GDP rose from 25.2% in 1994 to 30.2% in 2003, and manufactured exports’ share of GDP went up from 35.5% to 49.3%. The growth in manufactured goods and merchandise (all goods) production and exports is the principal reason why Southeast Asia has survived the onslaught of China and recovered from the Asia Crisis over the past decade.

However, the intensified manufacturing dependence is not a bad development at all. It demonstrates that the “Sino Hollow” thesis is probably not valid (see our October 7, 2004, note of this title), and that Southeast Asia retains good manufacturing growth potential and can grow strongly and structurally if it further develops and exploits its complementary economic relationship with China.

Export- or Domestic Demand-Led Growth?

A large number of international investors believe that Southeast Asia will either have to export well, i.e., economies will have to stay extremely export-driven/outward-oriented, or successfully shift to a sustainable domestic demand strategy. They thus tend to build their investment case on either rising trade with a prosperous China or a stronger domestic demand thesis.

These investors are not wrong. However, Southeast Asia is likely to have to continue to count on both. We believe it is quite possible that the region will continue to enjoy both export and domestic demand growth. Positive GDP growth trends and output potential can accommodate both. Hence, the correct investment theme would be to appreciate that traditional exports — mass-manufactured or generic soft or hard commodity exports — will not generate enough income to see the region to prosperity. The larger Southeast Asian nations need a balanced strategy as outlined in the dual-track discussion above.

The balanced dual-track strategy is the key, because it provides the critical economic linkage between growth in the second-track sectors, with both second-track-driven exports and second-track-led structural resilience in domestic demand. Thai Prime Minister Thaksin’s dual-track experiment over the past four years has clearly demonstrated that properly stimulated second-track sectors create domestic demand resilience. Underdeveloped agricultural, rural, grassroots, and SME sectors are capable of generating better multipliers, as leakage to imports on income created is fairly small. At the same time, new entrepreneurs in the non-mass manufacturing sectors are carving out export niches that are not in direct competition with China or other generic manufacturers elsewhere.

Exports have consistently outgrown domestic demand in ASEAN over a long period. ASEAN can structurally underpin the export sectors through the development of export-oriented non-mass manufacturing in the second-track sectors. This would generate a great deal of domestic demand resilience as second-track sectors are stimulated. Every ASEAN economy has increased exports faster than domestic demand over the past decade — this is where the opportunity lies for sustainable second-track-driven domestic demand growth.

Private Consumption- or Investment-Led Growth?

International investors who subscribe to the domestic demand boom thesis tend to put their faith in Southeast Asian private consumption. They believe the region over-saved and over-invested in the 1980s and ’90s. Hence, they think a private consumption boom is both a “default” outcome — as investment gives way to private consumption — and a necessary one if Southeast Asia is to salvage its growth, given the rise of China and the Asia Crisis. I was a subscriber to such a consumption thesis until quite recently. However, I now disagree on the basis of the following observations:

First, with the exception of Indonesia, Southeast Asia has used exports rather than private consumption as the engine of growth over the past decade. The so-called structural boom in private consumption has taken place only in Indonesia. For the other four countries (Singapore, Malaysia, Thailand, and the Philippines), private consumption to GDP ratios in 2003 remain roughly the same as in 1994, as well as the average over the 1994–2003 period. In other words, there is no fundamental “macro” expansion in private consumption (however, the banking system’s orientation towards consumers and away from corporates in the region over the past decade may have contributed to expansion in household balance sheets). More significantly, in Indonesia, the structural lift in private consumption — from sub-60% in 1994 to almost 70% in 2003 — was hardly a sign of economic strength or economic prosperity but rather a “default” phenomenon of corporates and households massively scaling back their investments and contracting their balance sheets. Concomitantly, households trimmed their wealth or reduced their rate of savings in order to sustain living standards in the face of massive inflation, currency devaluation, and falling real income after the Asia Crisis.

Second, there are serious institutional barriers to raising private consumption. Young demography, institutionalized or forced saving social structures, the high price of property relative to income, unequal distribution of income and wealth, and undervalued exchange rates all contribute to excessive saving. In my view, these institutional barriers will remain for a long time, thus dimming the prospects for private consumption.

Instead of private consumption, we see Southeast Asia embarking on a structural boom in domestic investment. The economic and policy rationale for a structural investment boom, the macro magnitude and economic implications of such a boom, and the “content” of such investment are critical to understanding the forthcoming investment boom.

Economic and policy rationale. While Japan and the four Asian Tigers (Singapore, Hong Kong, Taiwan, and South Korea) may have already passed the phase of rapid capital accumulation, the larger ASEAN four that are still low in per capita income must use new productive investment to boost future growth potential. (We believe Singapore has largely exhausted domestic investment opportunities and may not raise its domestic investment ratio further. That is why its external economy strategy centers on deploying excess saving in acquiring foreign assets.) Sources of productive investment would include appropriate infrastructure, upgrading the value chains of existing economic activities, and new second-track economic development.

Macro magnitude and economic implications. Among the larger ASEAN four, Thailand and Indonesia possess more certainty of generating a structural investment boom. Thailand’s average savings rate of 34% from 1994 to 2003 means there is considerable room for its gross investment rate to rise from the present 25% to perhaps 35–36% over the next few years. We believe that is exactly what Mr. Thaksin wants to do over the next few years. In the case of Indonesia, its gross investment ratio has fallen from 31% in 1994 to only 19% in 2003, while its gross savings ratio stood at 24% at the end of 2003. Its much higher average savings ratio of nearly 28% indicates room to lift the gross investment ratio by 10% of GDP. In our view, shrinking the present current account surplus to zero or even running a small deficit at 1–2% of GDP would not have a negative influence on the macro prudence and stability enjoyed by both economies.

Both Malaysia and the Philippines possess good scope for a lift in investment as well. Malaysia has consistently generated very high savings (44% of GDP), and the Philippines has considerable scope to raise its present savings rate to at least in the low 20% area, if the present round of revenue enhancement efforts coupled with structural fiscal reform results in a significant reversal in the government’s deficit trend. Raising the investment rate to the low 20% level could trigger a significant rise in investment in the Republic. However, in the case of Malaysia, some investment uncertainty emanates from the fact that the government is attempting to reduce its investment role. In the Philippines, the battle on the present round of revenue enhancement moves and structural fiscal reform is far from complete.

Content of investment boom. During the last phase of the investment boom, i.e., the late 1980s to mid-1990s, Southeast Asia splurged largely on unproductive investments (many high-end condominiums, golf courses, and white elephant infrastructure) that are wasteful and on generic mass manufacturing production capacity that is no longer relevant to the region’s new growth strategy. The new phase of investment will require the region to boost the productivity of second-track sectors such as services, agriculture, agro-businesses, SMEs, and grass-roots sectors. It should also focus on boosting the productivity of education and the government, as well as infrastructure to support these second-track activities.

Currency Revaluation — Boon or Boom?

Some quarters of international investors are advancing the idea that as the US Federal Reserve drives down the value of the dollar and China finally submits to outside pressure to revalue its currency or implement exchange rate flexibility, the unwinding and revaluation/appreciation of the ringgit peg as well as appreciation of other Southeast Asian currencies under their managed float/basket peg regimes would warrant rising optimism on Southeast Asian markets.

We think these investors would be proved right if the Fed succeeds and China succumbs. There would be short-term capital gain on Southeast Asia investment holdings. Also, currency revaluation/gains would render a domestic demand boom quite probable in Southeast Asia. However, there might be at least two opposing structural impacts — one positive and one negative — resulting from such a titanic currency move.

A positive structural development could take place as Southeast Asia exploits its currency gains to help fund its own investment boom, since foreign capital goods that are essential for capital formation would become cheaper. The currency gains would also favor domestic demand in general as imports become cheaper, and a typical monetary response to currency revaluation is to allow for some degree of domestic monetary expansion. More significantly, the currency gains would help sharpen the region’s focus on second-track development as its generic mass-manufactured exports become less competitive and less in demand in the global marketplace.

A negative structural development would occur if a domestic demand boom were not managed properly. The region might take the easy route of compensating stronger currency-induced export deterioration with a loose money-induced unproductive asset boom rather than the tough journey of restoring export competitiveness through productive investment. This has happened in Japan and, to varying degrees, in the four Asian Tigers since the Plaza Accord in 1985.

New York Times: Economists Have Advice for Buyers as the Art Market Heats Up by Eduardo Porter

Economists Have Advice for Buyers as the Art Market Heats Up
By EDUARDO PORTER

Art prices are setting records again. In early November "No. 6 (Yellow, White, Blue Over Yellow on Gray)" by Mark Rothko was auctioned at Sotheby's for a record $17.4 million, almost 50 percent above the top end of Sotheby's estimate. "The Ninth Hour," a room with a lifesize wax pope felled by a meteorite, by the Italian artist Maurizio Cattelan, fetched $3 million at auction at Phillips, de Pury & Company, also exceeding its top estimate by half.

Not only are modern and contemporary artists being treated like pop stars, but earlier American masters are also soaring like late-1990's Internet stocks. Today Sotheby's is putting "Group With Parasols (a Siesta)," by John Singer Sargent on the block with a top estimate of $12 million. This would be a record for the artist at auction.

"We have more collectors today willing to spend more money than we've ever had," said Dara Mitchell, a director of the American paintings department for Sotheby's.

These rates of return are now attracting the interest of financial investors. In Britain, there is the Fine Art Management Fund, which has been in the market since March. A former co-owner of Phillips, de Pury & Luxembourg established Artvest, an art investment company, in the spring. The New York-based Fernwood Art Investments plans to establish several funds next year to buy and manage art portfolios. And virtually every bank on Wall Street has an art advisory group to assist rich clients.

The renewed appetite for art as an investment is rekindling interest in developing systematic ways to assess the value of art and is drawing attention to a small number of scholars who have been applying economics to this new asset class.

Two pioneers are Michael Moses and Jianping Mei of the Stern School of Business at New York University. Mr. Moses and Mr. Mei developed an index of repeat sales of the same work of art, compiled from the prices of thousands of artworks sold at auction since 1875. They found that the compound annual rate of return of art from 1953 to 2003 was 12.1 percent, slightly higher than the Standard and Poor's 500 stock index.

Mr. Mei and Mr. Moses also found that art prices have a low correlation with stocks, so art can enhance the performance of a portfolio of equities. Perhaps most interestingly, they found that the art-dealer maxim that masterpieces are the best investment is wrong. According to their index, masterpieces - usually meaning the most expensive works of art - tend, instead, to appreciate less, or depreciate more, than the art market as a whole.

Economic analysis has also exposed some other peculiar behavior. Two economists from Oxford University have found that presale estimates by auction houses have some systematic biases. In contemporary art, for some reason, the most recently executed artworks are overvalued. For Impressionist and modern art, physically wider paintings may be underestimated.

David Galenson, a professor of economics at the University of Chicago, has been using the prices of artworks at auction to study patterns of creativity. His findings include useful insights into what makes art valuable. For instance, collectors might think again before paying big prices for late pieces by Pop artists. Their most expensive and critically acclaimed work, according to Mr. Galenson's analysis, was done at the beginning of their careers, when the breakthrough idea that took them to the top - the mechanical reproduction of serial images, for example, or blowing up cartoon frames - was still fresh. The Abstract Expressionists, on the other hand, might be better bought old - once they have experimented enough.

Mr. Galenson splits creativity into two camps, inductive and deductive. Inductive-minded artists - say, Claude Monet or Jackson Pollock - will experiment endlessly, with no precise endpoint in mind. Deductive conceptualists, on the other end, rely on the great revolutionary idea that springs forth fully formed - Marcel Duchamp's 1917 urinal, "Fountain," for instance, or "Les Demoiselles d'Avignon," which Picasso painted when he was 26. "With conceptual artists you can usually express their real contribution in a sentence," said Mr. Galenson. Mr. Galenson also picks out a broad shift in the market's taste over the last half century, as the appetite for innovation favored the quicker, deductive approach and thus tended to reward younger artists. In particular, he found that artists born before 1920 tended to do their most important work after the age of 40, while those born after 1920 peaked before hitting 40.

"A persistently high demand for artistic innovation has produced a regime in which conceptual approaches have predominated," Mr. Galenson wrote in a paper. "The art world has consequently been flooded by a series of new ideas, usually embodied in individual works, generally made by young artists who have failed to make more than one significant contribution in their careers."

Todd Millay, vice president in charge of strategy and product development at Fernwood Art Investments thinks this economic approach is helpful. "It's taking the tools and techniques which have been useful to understand other sectors of the economy and applying them to the art market," he said. Mr. Millay is developing quantitative techniques that Fernwood will use to build its art portfolio. Mr. Moses said he and Mr. Mei are also putting together a pricing model based on variables including the number of times an artwork work has been exhibited, written about or sold. And their analysis can provide some benchmarks.

For instance, the Sargent up for auction today will be sold, by Sotheby's estimate of $9 to $12 million, at a price somewhere between 375 and 500 times what it fetched in 1962. But Mr. Mei's and Mr. Moses's index of American art has appreciated only 136-fold in that period. "If I'm looking for a financial return, maybe these prices are a bit high," Mr. Moses said. "If you tend to buy above the index-inflated purchase price, your future returns are going to suffer."

Ms. Mitchell of Sotheby's stands by the value of the Sargent nonetheless. "Paintings of uniquely superior quality appreciate to a greater degree," she said. "Great paintings have a different curve." She argued that auctioneers have a pretty good handle on what an artwork is worth, benchmarking against other recent works by the artist sold and the overall state of the art market.

Auction houses have a big advantage: they already know the fairly small number of people who can spend a few million dollars on a painting. That means they have a pretty good idea of who is likely to bid how much for the next big artwork to be put on the block. "We have relationships with collectors seeking works from certain artists," said Matthew Carey-Williams, senior specialist for contemporary art at Sotheby's. "The first thing we say when we look at a piece of art is 'who is going to buy this?' "

Indeed, many art dealers tend to mistrust these economic approaches to art. Andre Emmerich, the New York collector and dealer, argues that there is no systematic method that can measure the shifting tastes that ultimately dictate the value of art in the market. "I'm not very good at these abstract theories at all," Mr. Emmerich said. "Art has much more to do with gut than with anything else."

Even some of the proponents of a more analytical approach to art say it is uncertain how much these ideas will help investors beat the art market. Merely measuring the market is tough, because there are so few public transactions to base any analysis on. And many deals take place privately between dealers and collectors, so their details are frequently not known.

Mr. Galenson argues that the art auction market is pretty efficient. Indeed, prices tend to reflect what art critics like and dislike. Orley Ashenfelter, a professor of economics at Princeton who studies art auctions, said all this analysis wass interesting, yet "I don't know how you can make money from this."

Vincent Lam of Quam Asset Management: "Reminbi-Appreciation Is A Matter Of Time"

Reminbi: Appreciation Is A Matter Of Time

There are two places in the world that is full of hot air -- hot gossips of celebrities and speculations in the stock market, and this is particularly the case when the jobs have just become more secure, and people have more leisure time to gossip and more spare money to gamble (and to lose). Since this is a financial column, and we would not like to step into the profession of the paparazzi, and therefore we will only focus on the hot air that is ballooning in the stock market. This time I will not bore you with the Macau concept again, which we have discussed several times on other occasions, but a more relevant issue -- the speculation of a potential revaluation of the Reminbi.

RMB Appreciation More Than Hot Air

Last Friday, the rumors have it that China might decide to revalue its currency in the coming few days, and Beijing could reach a decision at an annual high-level economic meeting over the weekend. When readers read this column, they might have realized that if these rumors is true or not. But my impression is that Beijing might have actually made up its mind to revaluate the RMB, and the hot air will likely precipitate into rock solid ice, the only matter is only the timing and the extent of the revaluation. Why? That is probably in the best interest of China and at the same time it can fulfill the needs of the rest of the world.

China being the world's most populated country is rich in population but short in natural resources. Since mid-2001, the US dollar has depreciated against the Euro by almost 38%, or in other words the Euro has appreciated over 58% against the greenback, and as a result of both a weakening US dollar and the persistent high growth in the PRC economy, China has imported much more natural resources, which dramatically reversed China's trade surplus from a positive ~US$6 billion in December 2003 to a trade deficit of ~US$6 billion at the beginning of this year. Due to rising prices of import raw materials, goods and services, inflation soared to a dangerous level of over 5% in the middle of this year, forcing Beijing to cool off the economy by both fiscal (austerity measures at the end of the first quarter) and monetary policies (raising interest rates for the first time in more than nine years).

If China continues to let the RMB stay pegged with the extremely weak USD, then China is risking an uncontrollable inflation and also a resurgence of trade deficits, which could be detrimental to the PRC economy in general and in particular to the banking system. For a country whose banking system has non-performing loans as a percentage of its annual GDP of over 48%, it needs to maintain a strong current account balance (both trade and net capital inflows through foreign direct investments) in order to defend against any potential attacks in the banking system. Inflation could also create social problems, as the salaries of the lower income class are unable to catch up with ever-rising prices.

Kill Two Birds with One Stone

Although raising interest rates can perform the same task, it is unable to solve the problem of rising import raw material costs. The only way to kill two birds with one stone, i.e. cool off domestic inflation and at the same time reduce potential trade deficits, is to let the RMB appreciate.

Depreciation of USD: A Conspiracy Theory

The European Central Bank (ECB) originally claimed that it might intervene in the currency market, but after the G20 meeting over the weekend it suddenly had a 180-degree change in attitude. We don't know what had been discussed during the meeting among the US Federal Reserve, Bank of Japan, and the ECB, but what we know was that they have since become silent on the currency market movements, which the market has interpreted as a agreement to let the greenback to continue to weaken. We suspect that this was probably a tactical measure to force China to appreciate the RMB.

Long before that, John Snow of the United States had said that the United States would like to adopt a strong USD policy, which we all knew that he was bull shitting, but at the same time he has neither said the Euro nor the Yen was undervalued except the apparent under-valuation of the RMB, which indirectly sent out a message that the free-falling of the USD was actually targeting at forcing the PRC government to appreciate the RMB.

China, in the meantime, has already sent out messages indicating that she is actually willing to appreciate the RMB as long as the revaluation will not invite future attacks on further appreciation, and even if that is the case the People's Bank of China (PBoC) will be able to defend. So you may say that there has already been a consensus among the international powers. The last question is only that whether the PBoC is confident of itself to defend against any potential attacks on further depreciations, and if China gets the nod of potential help from the US, ECB and BOJ, or at least paying lip service to China by saying that they are contented with the extent of the pace of appreciation.

RMB Appreciation and HK's Asset Reflation

If China does appreciate its currency, and the most likely rate of appreciation will be similar to the exchange rate of the Hong Kong dollar, which has an official rate of US$1 per HK$7.8, or an appreciation of approximately 6%.

We disagree with Mr. Joseph Yam, the Chief Executive of HK's de facto central bank, that the purpose of hot money staying in HK is use HKD as a substitute for the RMB. Mr. Yam has underestimated the IQ of the speculators. Their target is not an appreciation of the HKD but the expectation of asset inflation in Hong Kong. One argument for HK's wages failing to increase is that we have cheaper alternatives just a few steps northwards in Shenzhen. With an appreciation of the RMB, the pressure on HK's wages and property prices will at least be eased, even though some doomsayers are saying that a 6% appreciation in the RMB is far from enough for Hong Kong to regain its competitiveness. Investors who hold this view have again grossly underestimated the productivity of HK's employees.

I know that even in Quam Research Team, there are still an overwhelming number of HK bears. As always, I always tend to be the more optimistic one. With the fastest growing economy as our hinterland there is just no need to be too bearish about the future of our economy.

One last remark, since the main purpose of the free-falling of the USD is not targeted at the Euro and the Yen, when China announces the appreciation of the RMB, speculators may find them to have been made use of, and soon betrayed by the ECB and BoJ.

- written by Vincent Lam, Director of Research & Advisory of Quam (IA) Ltd., and Fund Manager at Quam Asset Management Ltd.

Newmont Mining's Pierre Lasonde "Take Stock in Gold" published by the Resource Investor.com

Pierre Lasonde: Take Stock in Gold
By Tim Wood01

Dec 2004 at 11:05 AM EST
Resource Investor.com

If you really want to know what the next 5-10 years are going to look like, I tell people that the best thing to do is look back to the 1970s. I really loved the music of the 70s, but look at the economic conditions and you're going to find that today we live in a world that is very similar.

In the 1960s we had very strong economic growth in the US and high productivity and low inflation – same thing here in the 1990s – and then it was followed by the Vietnam War. Well today we have Al Qaeda's War. In Vietnam, America was fighting over communism. Today it's fighting Islamic fundamentalism. Same difference the French will tell you! Now the only reason the French know a little bit more is because they got their head handed to them in Vietnam, and they told the Americans "don't go there!". The French also had Algeria, and they said to the Americans you know what, don't go there. Because they got their backsides kicked in Algeria as well. It's not that they really are smarter, they've just been there first.

The next thing that happened in the 1970s is we had an oil shock. Oil went up five times between 1971 and 1974. Guess what? Between 1998 and 2004 oil has gone up five times!

The monetary policies of the 1970s were highly expansionary with a negative real rate of interest. Guess what we're having today? Negative real rate of interest for the last two years. The rate of inflation is actually higher than the Treasury Bill rate and it's likely to stay that way for a bit longer.

We also saw a huge increase in the budget deficit in the 1970s. Well, same today. We've gone from a surplus of $150bn to negative $450bn, that's a swing of $600bn in budget deficit. Look at the current account deficit in the US. It's now over $660bn. That represents 70% of the world's savings that this country has to have every year to live in the style we've been accustomed to. How long can that last? Not forever.

Finally in the 1970s we saw a huge increase in commodity prices and we can see that right here. Commodity prices represented by the CRB Index, the Commodity Research Bureau Index, went up 250% between 1971 and 1980. We're up 60% so far. Let me ask you, do you think that that's the end? Over a 10 year period 250% and over a two year period we're up 60%.

Let's look at the things that are not the same from the 1970s.

The first difference is inflation. In the 1970s, for those of you who have a few white hairs and for some who have no hair, inflation was a real problem. It peaked at something like 14-15%. Why? Well some of it was because of the dollar devaluation, some of it was because of price push inflation and a lot of it was cost push inflation that came from union bargaining who could afford to increase wages throughout the economy because there was no alternative.

Today we have a very different situation where China in particular, Asia in a global fashion, is exporting wage deflation. If you go to a Wal-Mart today 70% of the goods sold there are basically from Asia, a lot of it from China. These countries can produce anything at cheaper prices than anybody else. If there's one thing that you have to remember it's that China today is the world price setter for commodities that it buys and for the finished goods that it exports. That's a first in economic history where a country is so dominant in either what it buys or what it sells.

So, if you look at the US economy, do we have inflation? Yes. If you look at services, you know, Starbucks increased its coffee price; you try to go to a Broncos' game and tickets are up 50% over the last three years. Yeah, we do have some inflation but then on the other hand we have deflation that's exported in the products that you go buy at Wall-Marts or any other commodity.

It's like having your head in the oven and your feet in a bucket of ice. On average its feels pretty good and that's exactly what you've got – the inflation rate supposedly is around 2%, but in reality it doesn't feel quite that way because either it's really cold or it's really hot. And it's likely to stay that way for the next few years.

I think you're going to have some inflation that's going to come through on the finished product side because China's inflation rate is increasing and they're going to have at the end of the day to increase the currency too. So you will have China exporting a higher inflation but I don't think it's going to go from more than 4 or 5%, enough however to have real interest rates stay negative even if the Fed pushes interest rates to 3 or 4%. My view is that you're still likely to have negative real rate of interest which is very good for gold.

The next thing is savings. When you look at the savings rate: in the 1970s in the US it was about 8%. Today, believe it or not, it is close to zero. Last quarter in the United States the same savings rate was 0.4% of GDP.

How can you have a country continue to invest with zero savings? That's a huge problem and that's why the current account deficit is so high. It cannot go on forever. What's happened is that the rest of the world has been funding our current account deficit to the tune of over $600bn a year. Every year the US economy is being sold at the rate of 1% to the rest of the world. You can't do that forever. What's going to have to give is the currency.

The final difference with the 1970s is the amount of debt in the economy.

In the 1970s we had 130% gross total debt including corporate, government and private debt. Today we have that figure over 200% of GDP. The last time the US economy was over 200% of debt to GDP was 1930. Not a good reference point!

Consumers today are tapped out and over indebted; basically the Fed has painted itself in a corner. If the Fed was to raise interest rates to a level that would have a significant real rate of interest it would plunge the economy into a recession and possibly even worse.

It cannot afford to raise rates to 7,8 or 9%. Or even 5% for that matter. So, what gave in the 1970s? Who was the big winner and who the big loser? The big loser was the US dollar.

If you look back to the 1970s and you look at the two major currencies against which the dollar depreciated, well it was the yen and the Deutsche mark and funny enough the only difference between the two was two zeros. The yen was 350, the Deutsche mark was 3. 50, and where did they end up? They ended up at 165 and 1.65, for a depreciation of over 50% of the dollar against these currencies.

Who was the big winner? Well, there was one big winner and it was gold.

The gold price went up 2500% from 1970 at $35 to 1980 at $850; for one minute it was $850. That was okay! Gold was undervalued because don't forget at that point in time gold was fixed by the government so if you really think about it and you start in 1974 when gold was, had already been loose for a couple of years, gold really went up from about 100 to, it did go to $800 on a, but let's say 600, that's still about a 500% increase between 1974 and 1981 or 82.

Gold today is a currency once more.

If you look at the gold price vis-à-vis the dollar euro relationship what you're going to find is that that explains the correlation between gold and the euro dollar relationship. It explains about 90 to 95% of the change in the value of the gold price.

Gold today is as close to a currency as you will ever see and gold growing in the future and our view is and we've been saying it now for four years, the American dollar has got to go down. The dollar has been the best export that the US has ever manufactured!

The central banks of the world today have got 2.1 trillion of those dollars. The question is if they just stop buying, that's enough to send the dollar down by 50%. If they start selling it's going to get even worse.

We don't think it's going to go there because at the end of the day when we look at China and Japan in particular, they want the economy to continue exporting so if there's anything that's managed in the world it's those two currencies.

Some people have gold conspiracies, I don't know about that. The one thing I do know is that those currencies are managed currencies and they are going to probably let them revalue against the dollar but in a very stepwise way. I tell people that one thing about China is that they do things in a Chinese way, which means that on their own time. Tight now my feeling is – and I'm sure Marc Faber is going to talk far more about it and he knows more than I will ever know – but my feeling is it's going to be a very stepwise fashion, you're going to have to wait for that.

I would like to go over something that we first published in our annual report in 1999. It is the Dow Jones Industrial Average divided by the gold price. Some of you have probably seen it in other places; I think we were the first one to put this out.

What it gives you is a view of the last 100 years of paper versus hard assets. It's very interesting because if you go back to the 1920s, for example, that was your peak. In 1929 it peaked at 18:1 so the gold price was $20 and the Dow was 360 points. And then the excesses of the 1920s had to be corrected so then we entered into a hard asset bull market and by definition, a paper bear market that lasted 3.5 years and bottomed in February of 1933 at 1.95:1 so gold went up to $35 at that point and the Dow was around 42 to 44.

The Dow by the way lost 90% of its value in four years.

Then the ratio went sideways for about 10 to 15 years and then started a bull market right after the war in ‘45, ‘46 and peaked again in 1966 at 28:1. At that point gold was $35 if you remember. We needed another generation to correct the excesses that had been created in the previous 20 years and those were the 1970s.

Interestingly enough in the 1970s we saw a bull market in hard assets; commodity prices going up. I started in this business in 1973 when copper was $1.60. The equivalent today would be a 3.50 or 4 dollar copper price. Can you imagine if you had copper at these prices? You know what? It could well happen!

The bull market in hard assets lasted 14 years and it topped out in 1980 at a ratio of 1:1. The Dow in 1980 was 800, gold was 800. Twice in a century and then what happened? Well we had a bull market in paper assets and what a bull market we had; an incredible one.

The top end in 2000 peaked at 24:1. Now four years later we are 23 or 24 to 1 and here's the question. If that bull market in hard assets is to mimic what we've seen twice in the past 100 years and go back to the 1:1 ratio; I ask you, where do you think the Dow's going to bottom? And I'll tell you where the gold price could go. For some of you it's like, "well is that possible?"

The Dow today is 10,500 in case you haven't quite noticed, OK, so if you're real bearish on the Dow where do you see it? 5,000? I don't know where it's going to bottom and no-one knows and no-one knows the future and no-one knows how much inflation and how much money printing we're going to have here in the United States or anywhere else and you know when you talk about the US dollar having to go down against the euro and the yen. But believe me I don't think for one second that the euro is a better currency than the dollar or that the yen for that matter is a better currency. It's only a relative game. At the end of the day all of these currencies will have to depreciate against the only currency that is not a managed currency and that is gold.

When I look at the problems that the Europeans are going to have over the next 10 years with the baby boomer retiring and their unfunded liabilities in terms of healthcare and pension – those are in the trillions of dollars they will never be able to fund those. What are they going to do?

They're going to depreciate their currencies. Well heck what are they going to depreciate against? The dollar? The dollar's in no better shape. The yen? The debt in the Japanese economy, we're at 200% of GDP, they're even worse. The only place is the dollar.

When I look at the gold price and commodity prices over the next 5 to 10 years I do believe that you're going to see gold with three zeros at the end, but you're going to have to be patient because I don't think that you're going to see that this year or next year. I think it's going to be five to eight years down the road, it takes time for these things to happen.

I do believe that the dollar is going to continue to depreciate against mostly the Asian currencies at this point.

If I look at the euro, I was in Europe, in Italy a couple of months ago I had to get a haircut, it was $55 in a barbershop! I just don't think the euro is such a great currency.

When the Italians are going to Switzerland for shopping because it's cheaper in Switzerland, you've got a problem! And this is what's happening. I actually have a friend who has a shopping mall on the border in Switzerland, right on the border with Italy, he built it 20 years ago and said: "Pierre it was the worst thing I ever did". In the last six months he tells me: "you know what it's unbelievable, the place is full now".

So no, you're going to have depreciation of all of these currencies against the only currency that will appreciate and that is going to be gold. But over the next 12 months I think that you're going to see gold maybe up to $500 and then it could mark time until we see the next big move in the Asian currencies.

We could see the dollar against the euro going up to 1.40, maybe 1.50 but frankly I can't see it any higher than that, it's already well past it's due date, but against the Asian currencies I think you have a 50% move and that's going to be the next really big move.

Then the question is how do you fund all the retirement liabilities. These issues are going to start creeping up in the next 10 years when in the US for example 77m baby boomers are going to start to retire. In Italy in the next 10 years the average age of the population is going to go from 45 years to 54 years old. All of a sudden you've got a huge increase in the aged population. How do you fund the healthcare, the retirement? They haven't addressed any of those issues.

So when I look at that in the long run I am very, very positive on the gold price. And with that I thank you very much.

Prudent Investor Reminisces: "The Philippine Mining Index Lags the World" Sept 25, 2003

In September 25th of 2003, your 'lone wolf' cried for a BUY on mining issues given that macro developments were imminently directed towards the Philippines' role as a major supplier for commodities particulary on the metals. My article was published in international websites as the goldseek.com and safehaven.com....

The Philippine Mining Index Lags the World
Guest Editorial: Benson J. Te


“The country is ranked second in the world in gold reserves, third in copper, and sixth in chromite; but mining has dropped from 26% of export earnings 20 years ago to only 6% today. And not because the Philippine economy has boomed; it's been the worst in East Asia for decades. Copper production, for instance, has dropped 40% since 1981.”-Doug Casey, International Speculator

The resource rich country is an upcoming significant player in the supply dynamics of gold and other industrial metals. Despite the abundance of its natural resources, the mining industry remains moribund largely due to the depressed commodity prices that plagues the industry for more than a decade, aside from other factors such as taxes and regulation, environmental concerns, as well as other usual developing country ailments as lack of infrastructure, corruption, peace and order and political stability. However, while the government has been working hard to revive the industry, gold’s renaissance has not yet flowed into the revival of the industry itself, as evidenced by the lackadaisical movements of the prices of the mining companies, as signified by the mining index.

The market capitalization of the entire Philippine Stock Exchange is only about US$ 21.8 billion making it one of the smallest stock markets in the world. Its 30-company benchmark composite index, the Phisix, has a market capitalization of US$16.8 billion while the mining index comprising of a piddling 6 companies is capitalized at $112.5 million only. Its 2002 GDP to market capitalization (P55 to a $US) is at 29%.

Moreover, of late, the Phisix have joined the growth in global equity markets arising from the endless stream of money supplies brought about by the loosening of the monetary spigot by the world’s central banks. According to Mr. William Pesek Jr., Asian analyst for Bloomberg, “The MSCI Asia Pacific Index, a regional benchmark, is up more than 27% this year. The Thai Shares alone are up over 68% in US dollar terms. Indonesia shares are up 45%, while the Philippine Stocks are up 25%.”

Overseas investors or portfolio flows comprise a significant share of the traded volume during the latest run-up which begun during the latter portion of May of this year. Since June, despite the political stresses hounding the government, overseas investors plunked in more than $ 95 million in equity assets acquisitions; however, most of these purchases were seen in the index heavyweights, with hardly a smidgen for mining issues.

While it is understandable for money flows to be directed to emerging markets due the several factors, as enumerated by BCA Research, such as rapidly improving economic fundamentals, short-term interest rates below dividend yields, cheap currency, stimulative monetary policies and inexpensive equity assets. The prospects of a continuing rise in commodity prices due to the tightening of supplies and possibly in combination with mounting demand from the rapidly expanding China and India, or from the steep fall of the US dollar, should highlight the potentials of mining and resource based companies in our region too.

Compared to mid-November 2001 prices, London’s second fix spot gold prices as of September 23, 2003, grew 39.63% while major mining global indices had remarkable returns as the HUI 232.64%, Australian Gold Index 186.08%, SA Gold Index 183.58%, GOX 109.27%, XAU 87.54%, while only the Canadian S&P/TSE Gold Index grew a measly 51.74% close to the Philippine Mining Index’s 33.46%.

As Dr. Marc Faber points out, “it is important to understand that the emerging economies of today are the lowest-cost producers in practically every sector of the global economy.” Since the Philippines hold one of the largest reserves of gold and other industrial metals could it be that these investors, whom have been buying into our market, have overlooked the potentials from the industry’s viewpoint?

Benson J. Te

****

Businessworld: High Court upholds mining law

High Court upholds mining law
By Ma. ELISA P. OSORIO, Reporter

'The Constitution should be read in broad life-giving strokes. It should not be used to strangulate economic growth or to serve narrow, parochial interest...Rather, it should be construed to grant the President and Congress sufficient discretion and reasonable leeway to enable them to attract foreign investment, as well as to secure for our people and our posterity the blessings of prosperity and peace.'

The Supreme Court yesterday, with a vote of 10 to 4 with one abstentation, effectively reversed itself as it declared the Philippine Mining Act as constitutional.

In a 246-page decision, the court en banc overturned its January decision that nullified the mining law (Republic Act 7942) as well as the Financial and Technical Assistance Agreement (FTAA) between the government and Western Mining Corporation Philippines, a wholly-owned subsidiary of Western Mining Corporation Holdings Limited of Australia.

Those who voted for the reversal of the January decision were Chief Justice Hilario G. Davide, Jr. as well as justices Artemio V. Panganiban, Reynato S. Puno, Leonardo A. Quisumbing, Angelina Sandoval-Gutierrez, Alicia Austria Martinez, Renato C. Corona, Dante O. Tinga, Minita V. Chico-Nazario and Cancio C. Garcia.

Those who dissented were justices Consuelo Ynares-Santiago, Antonio T. Carpio, Conchita Carpio-Morales, and Romeo J. Callejo. Justice Adolfo A. Azcuna abstained because he was a former lawyer of one of the parties.

The decision, penned by Justice Panganiban, ruled that the 1995 FTAA did not contravene the 1987 Constitution because the charter expressly allowed service contracts in "large-scale exploration, development, and utilization of minerals, petroleum and mineral oils."

'LIFE-GIVING STROKES'

"The Constitution should be read in broad life-giving strokes. It should not be used to strangulate economic growth or to serve narrow, parochial interest," the court said.

"Rather, it should be construed to grant the President and Congress sufficient discretion and reasonable leeway to enable them to attract foreign investment, as well as to secure for our people and our posterity the blessings of prosperity and peace," it added.

The court also said the government may undertake mining activities through "agreements with foreign-owned corporations involving either technical or financial assistance."

The court also said there was nothing unconstitutional about the mining law's Implementing Rules and Regulations that were drafted by the Department of Environment and Natural Resources.

It noted that the State, through the President, still retained and exercised full control over mining operations despite FTAAs.

"The drafters [of the Constitution] in fact knew that the agreements with foreign corporations were going to entail not mere technical or financial assistance, but rather, foreign investment in and management of an enterprise for large-scale exploration, development, and utilization of minerals," the court decision read.

"Indeed, the Chief Executive is the official constitutionally mandated to enter into agreements with foreign owned corporations," it added.

The law also states that Congress may review the action of the President regarding "every contract entered into in accordance with this [constitutional] provision," the court said.

In reversing itself on earlier nullifying the mining law, the court also said "the judiciary should not inordinately interfere in the exercise of this presidential power of control over the EDU [exploration, development and utilization] of our natural resources."

The court also said its new decision would answer "the need to develop our stagnating mining industry and extract what NEDA [National Economic and Development Authority] Secretary Romulo Neri estimates is some $840 billion worth of mineral wealth lying hidden in the ground, in order to jump-start our floundering economy on the one hand, and on the other, the need to enhance our nationalistic aspirations, protect our indigenous communities, and prevent irreversible ecological damage."

"Verily, the mineral wealth and natural resources of this country are meant to benefit not merely a select group of people living in the areas locally affected by mining activities, but the entire Filipino nation," the court added.

The Supreme Court, last January 27 struck down as unconstitutional the provisions of the Philippine Mining Act of 1995 that allowed 100% foreign-owned firms to exploit the country's mineral resources.

In that 95-page ruling, the court en banc declared provisions of RA7942 void in so far as they pertained to the so-called FTAA.

That ruling likewise declared as void the FTAA between the government and Western Mining.
WELCOME NEWS

Reacting to the decision, the Chamber of Mines of the Philippines said "the knowledge and wisdom of the court in this landmark case [was] expected to draw support from the entire business community, locally and internationally."

In a separate statement, American Chamber of Commerce of the Philippines Executive Director Robert Sears said the court decision would help the government "create jobs, increase revenues from exports, and bring in needed foreign direct investments."

Stock market analysts said the decision would also bode well for the local market and the economy.

In telephone interview, Astro del Castillo of First Grade Holdings, Inc. noted that mining, being an untapped sector for some time, had plenty of potential.

"This will open the floodgates [for developments] that will impact the country's fiscal problems," he said.

"They [foreign and local companies] will complement each other and enhance competition, which will result in more efficient operations for the sector," he added.

The mining and oil indices were up in yesterday's trading.

Jose Vistan, Jr. of AB Capital Securities, Inc. also welcomed the court ruling. "This is good news, which brings into the country not only potential capital but also technology. Mining companies short in capital can now tap the technology of those foreign companies and help the economy," he said.

He added the ruling was a "much-needed shot in the arm" for the economy to take off.

"Oil and copper prices are high. The Philippines is rich in these resources so the decision of the Supreme Court is good news for the economy, the stock market and the country as well. It is pro-business for a change," he added.

Meanwhile, Environment and Natural Resources Secretary Michael T. Defensor said, "We would now be assured of investments [in the mining sector], the economy would surely benefit from it. Any decision otherwise would have been disastrous for us."

"We see a potential $2 billion to $3 billion worth of investments during the first three years, and about $2 billion annually after that," he added.

Mr. Defensor also said, "There are about 30 potential investments with pending process of implementation because of the issue on mining. Now it is all systems go." -- with reports from Roulee Jane C. Calayag and Rommer M. Balaba

Marc Chandler: "World View: Dollar correction may not help deficit" published by the Financial Times

World View: Dollar correction may not help deficit
By Marc Chandler
Published: November 28 2004 22:10

Could investors buying the rumours of a Chinese revaluation get caught out by selling after the fact?

Forecasting the foreign exchange market is a mug's game, according to Alan Greenspan, chairman of the Federal Reserve. But his warning has not stopped many people from trying and sentiment towards the dollar is currently as negative as it has been in nearly a decade.

The macro-economic argument seems straightforward and compelling. The US has been living beyond its means, importing much more than it has been exporting and in the process becoming the world's largest debtor. At nearly 6 per cent of gross domestic product, the current account deficit is unsustainable and the long-predicted dollar correction is upon us. A substantial decline in the dollar, so the argument goes, would boost US exports and deter imports. It may also force up US interest rates, to compensate investors for the currency risk, and reduce US appetite for imports.

Asia is the critical zone and China at the epicentre because it is there that the deficit is concentrated and officials are loath to allow the currency market to bear the burden of the adjustment process. If China allows the renminbi to appreciate in some fashion against the dollar from the Rmb8.278 peg, the political and economic elites of other Asian countries will also allow their currencies to appreciate against the US dollar. This in turn will help balance US books and allow China to achieve some domestic objectives, such as cooling the economy and slowing inflation.

But there is good reason to be suspicious that depreciation on any reasonable scale will bring the US trade account into balance. One critical fact is that the movement of goods within the same company accounts for a significant part of US trade - nearly a third of US exports and almost 40 per cent of US imports - and this trade tends to be less sensitive to currency market fluctuations.

A review of recent patterns may be even more persuasive. The euro reached its nadir in October 2000 near $0.825. That month, the 12-month US-western Europe trade deficit was $59.35bn. By September this year, the euro had appreciated by more than 50 per cent against the dollar, yet the 12-month trade deficit stood at $110.87bn - an 86 per cent increase.

Canada's story is similar. The US dollar peaked against the Canadian dollar in early 2002 near C$1.62. It is now trading at about C$1.18, a loss of just over a quarter of its value. But over that period, the 12-month US trade deficit with Canada has grown by 24 per cent from $50.35bn to $62.40bn in September 2004.

Let us not forget Japan. After putting in its historical low in the spring of 1995, worth less than Y80, the dollar recorded its cyclical high in August 1998 near Y147.50. Having lost nearly a third of its value since, the dollar is currently trading near Y103. The US 12-month trade deficit with Japan has widened by almost 20 per cent to $73.1bn.

If there is no guarantee that dollar depreciation will reduce the US current account deficit significantly, what about the benefits to Asia of floating currencies? The assertions often appear exaggerated. Most countries that have adopted floating currencies did so reluctantly. This includes the US as much as Brazil and Argentina. Europe has been reluctant since the get-go to embrace the volatility that floating exchange rates imply. The euro itself is the logical culmination of attempts since the break-up of Bretton Woods to minimise foreign exchange volatility among key trading partners.

The US, western Europe, and even Japan enjoyed rapid growth and modernisation under fixed exchange rates and limited capital mobility. Many countries in east Asia have experienced a prolonged period of strong growth under similar conditions. In response to the 1997-1998 financial crisis, Malaysia resisted the liberalisation pressure. It pegged the ringgit and limited capital mobility. In recent years, Malaysia's economic performance is just as good, if not better than its neighbours.

This is the context for arguments by some developing countries that the G7's repeated calls for more flexible currency regimes amount to kicking the ladder after one has climbed off.

The non-deliverable forward market, largely the creation of investment banks to circumvent a country's capital market restrictions, currently implies less than a 4 per cent appreciation of the renminbi against the dollar over the next 12 months. This is close to the historical extreme and in the big picture represents little more than a drop in the bucket, especially given that labour costs in China are on the magnitude of 1/25 of US levels. This also seems modest given the flood of speculative money that has reportedly flowed into the east Asian equity markets in anticipation of an appreciation of the renminbi.

Moreover, there are signs of moderating inflationary pressures and the latest data also suggest fixed asset investment and loan growth has slowed, easing the economic pressure for a stronger currency. Of course, China faces numerous challenges but the case for a near-term foreign exchange rate adjustment does not appear as compelling as the speculative community seems to think. In addition, it is possible that, in the not too distant future, China will begin running small trade deficits - not with the US but with the world as a whole.

In spite of the clamour and seemingly nearly universal opinion, the evidence suggests that an appreciation of the Asian currencies, and particularly China's renminbi, is no panacea for either the US trade deficit or China's own economic challenges. Structural reforms are the key not price adjustments. Investors pouring money into Asian currencies and equity markets, betting on a significant revaluation of the renminbi are vulnerable to disappointment. And even if a small revaluation takes place down the road, these investors are vulnerable to "buy the rumour sell the fact" type of activity. Forewarned is forearmed.

The writer is a partner in Terra Capital Partners, a financial advisory firm.E-mail: marc.chandler@ worldnet.att.net