Government Intervention Equals Soaring Sugar Prices

In our earlier post Food Crisis Watch: Sugar On Fire- Writing On The Wall? we attributed the current runaway prices in world sugar partly to adverse weather (in India) which has affected supply, growing world demand, and most importantly, the unintended effects from government policies (e.g. export bans).

The Wall Street Journal gives a US perspective on the current sugar pricing dynamics... (all bold highlights mine-our comment below)

``Some of America's biggest food companies say the U.S. could "virtually run out of sugar" if the Obama administration doesn't ease import restrictions amid soaring prices for the key commodity.

``In a letter to Agriculture Secretary Thomas Vilsack, the big brands -- including Kraft Foods Inc., General Mills Inc., Hershey Co. and Mars Inc. -- bluntly raised the prospect of a severe shortage of sugar used in chocolate bars, breakfast cereal, cookies, chewing gum and thousands of other products.

``The companies threatened to jack up consumer prices and lay off workers if the Agriculture Department doesn't allow them to import more tariff-free sugar. Current import quotas limit the amount of tariff-free sugar the food companies can import in a given year, except from Mexico, suppressing supplies from major producers such as Brazil.

``While agricultural economists scoff at the notion of an America bereft of sugar, the food companies warn in their letter to Mr. Vilsack that, without freer access to cheaper imported sugar, "consumers will pay higher prices, food manufacturing jobs will be at risk and trading patterns will be distorted."

``Officials of many food companies -- several of which are enjoying rising profits this year despite the recession -- declined to comment on how much they might raise prices if they don't get their way in Washington.

``The letter is the latest salvo fired in a long-simmering dispute between U.S. food companies and the sugar industry over federal policy that artificially inflates the domestic price of U.S.-produced sugar in order to support the incomes of politically savvy sugar-beet farmers on the Northern Plains and cane-sugar farmers in the South. Most years, the price food companies pay for U.S. sugar is twice the world level.

``Ron Lucchesi, head of procurement for Gonnella Frozen Products in Chicago, which signed the letter, said current U.S. sugar policy distorts pricing. Though sugar accounts for only 0.5% of total costs at Gonnella, soaring sugar prices are "part of the equation" that already has led the company to raise prices for kaiser rolls, hamburgers and hot dogs, all of which include sugar.

``The issue is coming to a boil again because sugar prices, both in the U.S. and globally, have soared to unusually high levels for more than a year and show little sign of easing any time soon. Prices of sugar futures contracts have risen 95% so far this year, hitting a 28-year high in recent days. On Wednesday, raw-sugar futures jumped 4.8% to 22.97 cents a pound at the Intercontinental Exchange.

``Prices are up because the world is consuming more sugar than farmers are producing. One big factor: The world's largest sugar producer, Brazil, is diverting huge amounts of its cane crop to making ethanol fuel. Likewise, the food industry has complained bitterly in recent years about the U.S. ethanol industry's ravenous appetite for corn, which helped push up prices for that key ingredient too.

``More than half of Brazil's sugar-cane crop is processed into ethanol while about one-third of the U.S. corn crop is made into the alternative fuel. An erratic monsoon season in India also has led sugar analysts to reduce their production forecasts for the world's second-largest sugar producer.

``At the same time, U.S. sugar supplies are tight. In its monthly report on global farm markets released Wednesday, the Agriculture Department said it expects U.S. sugar supplies by September 2010 to drop 43% from this fall."

Some insights from the article:

-Import quotas limits sugar imports (hence limit supply)

-Import quotas signify as subsidy to the sugar industry.

-Limited supply against greater demand equals high prices.

-Consumers ultimately pay for higher prices from which the sugar industry benefits.

Hence subsidy is a form of taxation where to quote Murray Rothbard, ``Subsidy has always meant that one set of people has been taxed and the funds transferred to another group: that Peter has been taxed to pay Paul."

Ergo, consumers are taxed and the funds/rent go to the sugar industry.

-Moreover, ethanol "clean air" mandates (another set of subsidies) have been shifting the supply and demand patterns as agri feedstocks (US corn and Brazil's sugar) for biofuel based energy now compete with food.

-End result: shortages and skyrocketing prices. In short, runaway sugar prices is a prologue to similar patterns in agricultural produce.

Lesson: To quote Milton Friedman ``If you put the federal government in charge of the Sahara Desert, in 5 years there'd be a shortage of sand!”

Will China’s Stock Market Correction Spread Globally?

``We have seen that according to popular thinking, an asset bubble is a large increase in asset prices. A price is the amount of dollars paid for a given thing. We may just as well say, then, that a bubble is a large increase in the payment of dollars for various assets. As a rule, in order for this to occur there must be an increase in the pool of dollars, or the pool of money. So, if one accepts the popular definition of what a bubble is, one must also concede that without an expansion in the pool of money, bubbles cannot emerge. If the pool of money is not expanding, then people — irrespective of their psychological disposition — simply do not have the ability to generate bubbles in various markets.” Frank Shostak, How Can the Fed Prevent Asset Bubbles?

It looks likely that we may have reached a turning point for this cycle.

I’m not suggesting that we are at the end of the secular bull market phase, but given the truism that no trend moves in a straight line, a reprieve should be warranted.

To consider, September and October has been the weakest months of the annual seasonal cycle, where most of the stock market “shocks” have occurred. The culmination of last year’s meltdown in October should be a fresh example.

Although, this is not to imply that we are about to be envisaged by another crisis this year (another larger bust looms 2-4 years from now), the point is, overstretched markets could likely utilize seasonal variables as fulcrum for a pause-or a window of opportunity for accumulation.

A China Led Countercyclical Trend

My case for an ephemeral inflection point is primarily focused on China.

Since China’s stockmarket bellwether, the Shanghai Index (SSEC), defied “gravity” during the predominant bleakness following last year’s crash, and most importantly, served as the inspirational leader for global bourses, its action would likely have a telling impact on the directions of global stock markets.

In short, my premise is that global markets are likely to follow China.

True, the SSEC had a two week correction, which have accounted for nearly 11% decline (as seen in Figure 1) but this has, so far, been largely ignored by global bourses.

Figure 1: Stockcharts.com: The Shanghai Index Rolling Over

Nevertheless, the action in China’s market appears to weigh more on commodities on the interim. This should impact the actions in many commodity exporting emerging markets.

The Baltic Dry Index (BDI) which tracks international shipping prices of various dry bulk cargoes of commodities as coal, iron ore or grain has been on a descent since June.

This has equally been manifested in prices Crude oil (WTIC) which appears to have carved out a “double top” formation.

In short, there seems to be a semblance of distribution evolving in the China-commodity markets.

The possible implication is perhaps China’s leash effect on global stock markets will lag.

From a technical perspective, using the last major (Feb-Mar) correction as reference, a 20% decline would bring the SSEC to a 50% Fibonacci retracement, while a 25% fall would translate to 61.8% retracement.

And any decline that exceeds the last level may suggest for a major inflection point, albeit technical indicators are never foolproof.

Moreover, from a perspective of double top formation in oil; if a breakdown of the $60 support occurs then $49-50 could be the next target level.

As a reminder, for us, technicals serve only as guidepost and not as major decision factors. The reason I brought up the failure in the S&P 500 head and shoulder pattern last July [see Example Of Chart Pattern Failure] was to demonstrate the folly of extreme dependence on charts.

As prolific trader analyst Dennis Gartman suggests in his 22 Trading rules, ``To trade successfully, think like a fundamentalist; trade like a technician. It is imperative that we understand the fundamentals driving a trade, but also that we understand the market's technicals. When we do, then, and only then, can we or should we, trade.”

In short, understanding market sponsorship or identifying forces that have been responsible for the actions in the marketplace are more important than simple pattern recognition. Together they become a potent weapon.

So despite the recent 11% decline of the SSEC, on a year date basis it remains up by a staggering 67%.

Politicization Of The Financial Markets

Some experts have suggested that when global stock markets would correct, such would transpire under the environment of a rising US dollar index, since this would signal a liquidity tightening.

I am not sure that this would be the case, although the market actions may work in such direction where the causality would appear reflexive.

Unless the implication is that the impact from the inflationary policies has reached its pinnacle or would extrapolate to a manifestation of the eroding effects of such policies, where forces from misallocated resources would be reasserting themselves, such reasoning overlooks prospective policy responses.

The US dollar index (USD) has recently broken down but has been drifting above the breached support levels (see above chart).

It could rally in the backdrop of declining stock markets and commodity prices, although it is likely to reflect on a correlation trade than a cause and effect dynamic.

By correlation trade, I mean that since the markets have been accustomed or inured to the inverse relationship of the US dollar and commodities, any signs of weaknesses in the commodities sphere would likely spur an intuitive rotation back into the US dollar.

Some may call it “flight to safety”. But I would resist the notion that the US dollar would represent anywhere near safehaven status given the present policy directions.

However, if the US dollar fails to rally while global stocks weaken, then any correction, thus, will likely be mild and short.

So yes, the movement of the US dollar index is an important factor in gauging the movements of the global stock markets.

But one must be reminded that last year’s ferocious rally in the US dollar index was triggered by a dysfunctional global banking system when the US experienced a near collapse prompted by electronic “institutional” bank run.

This isn’t likely to be the case today.

So far, aside from the seeming “normalization” of credit flows seen in the credit markets, our longstanding premise has been that global authorities, operating on the mental and theoretical framework of mainstream economics, will refrain from exhausting present gains from which have been viewed as policy triumph.

Hence our bet is that they will likely pursue the more of the same tact in order to sustain the winning streak. The latest US FOMC transcript to maintain current policies could be interpreted as one.

Why take the party punch bowl away when the financial elite are having their bacchanalian orgy?

As we noted in last week’s Crack-Up Boom Spreads To Asia And The Philippines, ``Where financial markets once functioned as signals for economic transitions, it would now appear that financial markets have become the essence of global economies, where the real economy have been subordinated to paper shuffling activities.”

Where policymakers inherently sees rising financial assets as signals of economic growth, the reality is that most of the current pricing stickiness has been fueled by excessive money printing that has prompted for intensive speculations more than real economic growth.

Figure 2: New York Times: Hints of a Rebound in Global Trade?

For instance, Floyd Norris of the New York Times has a great chart depicting the year on year changes of global trade based on dollar volume of exports.

While there has indeed been some improvements coming off the synchronized collapse last year, the growth rates haven’t been all that impressive.

In short, rapidly inflating markets and a tepid growth in the global economy manifest signs of disconnect!

Yet global policymakers won’t risk the impression that economic growth will falter as signaled by falling financial asset prices. Hence, they are likely to further boost the “animal spirits” by adopting policies that will directly support financial assets and hope that any improvements will have a spillover effect to the real economy via the “aggregate demand” transmission mechanism.

Alternatively, one may interpret this as the politicization of the financial markets.

To give you an example, bank lending in China has materially slowed in July see figure 3. This could have accounted for the recent correction in the SSEC.

Figure 3: US Global Investors: Declining Bank Loans

According to US Global Investors ``China’s new lending data for July may be a blessing in disguise, as the slowdown can partly be attributed to a sharp month-over-month decrease in bill financing. Excluding bills, July’s new loans to companies and households were comparable to May and higher than April. With more higher-yielding, long-term loans replacing lower interest-bearing bill financing, margins at Chinese banks should improve as long as corporate funding demand remains strong and overall loan quality stays healthy.”

While this could be seen as the optimistic aspect, the fact is that aside from the overheated and overextended stock markets, property markets have likewise been benefiting from the monetary shindig- property sales up 60% for the first seven months and where residential investments “rose 11.6 percent, up from 9.9 percent in the six months to June 30” “powered by $1.1 trillion of lending in the first six months” (Bloomberg)

True, some of these have filtered over to the real economy as China’s power generation expanded by 4.8% in July (Finfacts) while domestic car sales soared by 63% (caijing) both on a year to year basis.

So in the account of a persistent weak external demand, Chinese policymakers have opted to gamble with fiscal and policies targeted at domestic investments…particularly on property and infrastructure.

Remember, the US consumers, which had been China’s largest market, has remained on the defensive since they’ve been suffering from the adjustments of over indebtedness which would take years (if not decades) to resolve (see figure 4).

Figure 4: Danske Research: US Consumers In Doldrums

And since investments accounts for as the biggest share in China’s economy, as we discussed in last November’s China’s Bailout Package; Shanghai Index At Possible Bottom?, ``the largest chunk of China’s GDP has been in investments which is estimated at 40% (the Economist) or 30% (Dragonomics-GaveKal) of the economy where over half of these are into infrastructure [30.8% of total construction investments (source: Dragonomics-Gavekal)] and property [24% of total construction investments]”, the object of policy based thrust to support domestic bubbles seem quite enchanting to policymakers.

Besides, if the objective is about control, in a still largely command and control type of governance, then Chinese policymakers can do little to support US consumers than to inflate local bubbles.

Aside, as we discussed in last week’s The Fallacies of Inflating Away Debt, “conflict-of –interests” issues on policymaking always poses a risk, since authorities are likely to seek short term gains for political ends or goals.

From last week ``policymakers are likely to take actions that are designed for generating short term “visible” benefits at the cost of deferring the “unseen” cumulative long term risks, which are usually are aligned with the office tenure (let the next guy handle the mess) or if they happen to be politically influenced by the incumbent administration (generates impacts that can win votes)”

In China, political incentive issues could be another important variable at work in support of bubble policies.

Michael Kurtz, a Shanghai-based strategist and head of China research for Macquarie Securities Michael Kurtz, in an article at the Wall Street Journal apparently validates our general observation.

From Mr. Kurtz (bold highlights mine),

``…far from being an accidental consequence of loose monetary policy, stand out as the purpose of that policy. The fact that housing construction must carry so much of the growth burden means policy makers likely prefer to err well on the side of too much inflation rather than risk choking off growth too early by mistiming tightening.

``Meanwhile, China's political cycle may exacerbate risks of an asset bubble. President and Communist Party Chairman Hu Jintao and other senior leaders are expected to step down at the party's five-year congress in October 2012. Much of the jockeying for appointments to top jobs is already under way, especially for key slots in the Politburo. Mr. Hu will want to secure seats for five of his allies on that body's nine-member standing committee, ensuring his continued influence from the sidelines and allowing him to protect his political legacy.

``This requires that Mr. Hu deliver headline GDP growth at or above the 8% level that China's conventional wisdom associates with robust job creation, lest he leave himself open to criticism from ambitious rivals. The related political need to avoid ruffling too many feathers in China's establishment also may incline leaders toward lower-conflict approaches to growth, rather than deep structural reforms that would help rebalance demand toward sustainable private consumption. Easy money is less politically costly than rural land reform or state-enterprise dividend restructuring. This is especially the case given that much of the hangover of a Chinese asset bubble would fall not on the current leadership, but on the next.”

So the “window dressing” of the Chinese economy for election purposes fits our conflict of interest description to a tee!

Overall, it would seem like a mistake to interpret any signs of a prospective rally in the US dollar on “tightening” simply because policymakers (in China, the US, the Philippines or elsewhere) are likely to engage in more inflationary actions for political ends (policy triumph, elections, et. al.).

Hence, any signs of market weakness will likely prompt for more actions to support the asset prices.

Inflationary Policies Have Vastly Been Changing The Market Landscape

``During a boom, inflation creates illusory profits and distorts economic calculation. What the free market does best is penalize the inefficient and reward the efficient. But when you get a boom, the rising tide lifts all boats…Because of these illusory profits, everybody wants to get in on the boom. Everyone thinks they can do everything…Furthermore, during inflation, the quality of work goes down. Everyone tries to manufacture products as quickly as they can. There's no emphasis on how long things will last…In general, people become enamored with get-rich-quick schemes. In fact, entire countries have done this with the collateralized debt obligation (CDO) market. Iceland, for instance, has become one big hedge fund. And now we're going to have entire countries go broke.” Doug French, Bubble Economics: The Illusion of Wealth

In the field of politics, rendering social services for the people is always bruited about as the ultimate goal.

Unfortunately, the harsh reality of life is that policymakers or political leaders and their bureaucracy are only concerned with their self interests. But the sad fact is that their erroneous interventionist policies have lasting adverse consequences on the society’s standard of living.

Worst of all, is that a big segment of the public have been deluded to adamantly embrace the promises of politicians and of the attendant false ideologies in support of their “robbing Peter to pay Paul” policies.

Also, in no way do inflationary policies work better than the market forces.

Another proof?

From an earlier article Myths From Subprime Mortgage Crisis, Ms. Yuliya Demyanyk of the Federal Reserve of Cleveland wrote how policies aimed to increase homeownership has markedly failed.

Again from Ms. Yuliya Demyanyk (bold emphasis mine)

``The availability of subprime mortgages in the United States did not facilitate increased homeownership. Between 2000 and 2006, approximately one million borrowers took subprime mortgages to finance the purchase of their first home. These subprime loans did contribute to an increased level of homeownership in the country—at the time of mortgage origination. Unfortunately, many homebuyers with subprime loans defaulted within a couple of years of origination. The number of such defaults outweighs the number of first-time homebuyers with subprime mortgages.

``Given that there were more defaults among all (not just first-time) homebuyers with subprime loans than there were first-time homebuyers with subprime loans, it is impossible to conclude that subprime mortgages promoted homeownership."

That’s why it pays never to trust politicians.

So in general, society vastly suffers under the artificial nature of bubble cycles caused by government interventionism.

Moreover, it isn’t just me this time bewailing how interventionism or how inflationary policies have been obscuring traditional means of evaluating financial markets.

Mr. David Kotok of Cumblerland Advisors in a fantastic discussion about Ricardian Equivalence [or as defined by investopedia.org as ``An economic theory that suggests that when a government tries to stimulate demand by increasing debt-financed government spending, demand remains unchanged. This is because the public will save its excess money in order to pay for future tax increases that will be initiated to pay off the debt”] demonstrates this.

From Mr. Kotok, (bold highlights mine, all caps his)

``We are issuing massive amounts of debt in order to finance loads of current consumption. Rational expectations would have the markets immediately adjust prices for the future tax burden associated with the servicing of the debt. But more than HALF OF THE WAGE EARNERS IN THE COUNTRY ARE NOW NOT PAYING ANY SIGNIFICANT INCOME TAXES. Sure, they are paying Social Security withholding and state taxes, but their share of the federal personal income tax receipts is very small. They are positioned with inconsistency when thinking about Ricardian equivalence, since they do not experience nor expect to experience the tax burden associated with the huge debt…

``The taxing decisions that impact the minority of the American wage-earner population are not made by them. Those decisions emanate from the Congress and the White House. Those policy makers have a time inconsistency which conflicts with successful Ricardian equivalence. Their time horizon is mostly less than two years until the next election. In the case of Obama it is less than four years, and the handlers of his political apparatus are already at work on the re-election campaign.

``So we have two inconsistencies at work. Agent inconsistency exists, wherein only the minority of the taxpayers is paying the longer-term burden of the substitution of debt for taxes. And time inconsistency, where the decision-maker's time horizon is much shorter than the expected debt-load servicing time horizon. Two inconsistencies equal a failure of the Ricardian equivalence.

``For portfolio managers this poses a difficult dilemma. We know about the inconsistencies. We can estimate the impacts when they are finally resolved. But we have no way to estimate WHEN the inconsistencies will emerge as the force that alters market values. And we cannot be sure of the method by which they will impose their imprint on the markets when they do. Sure, it could be higher taxation or slower growth or more inflation or a weaker dollar or flight of citizens or less productivity or diminished innovation. There are many such characteristics of a society that has overextended itself and has to pay the price. But WHEN and HOW and at WHAT COST? These are the imponderables.”

Again, parallel to the China example, the conflict of interests between the interests of policymakers and their preferred policies relative to the consequences to markets and the political economy are evolving to become major variables in the asset pricing dynamics and have increasingly been contributing to the growing state of non-Priceable Knightean uncertainty conditions.

When a group of distinguished economists wrote to the Queen of England explaining why “no one foresaw the timing, extent and severity of the recession”, they failed to explain to Her Majesty the following:

1) mainstream economics (via monetary and fiscal inflation) had been the primary cause of it, and since they’ve been the principal advocates they wouldn’t undermine the underlying theories that support it. In other words, mainstream economists are blighted with a bias blind spot.

As Murray N. Rothbard explains in Money Inflation and Price Inflation, ``There are very 'good reasons why monetary inflation cannot bring endless prosperity. In the first place, even if there were no price inflation, monetary inflation is a bad proposition. For monetary inflation is counterfeiting, plain and simple. As in counterfeiting, the creation of new money simply diverts resources from producers, who have gotten their money honestly, to the early recipients of the new money-to the counterfeiters, and to those on whom they spend their money.” (emphasis added)

2) mainstream economics deal with superficialities and unrealistic models and is constrained by the short term outlook.

``I think it is the inability to reconcile a reasonable treatment of radical uncertainty with the strictures of out-of-control formalism” observed Professor Mario Rizzo.

3) it isn’t true that no one foresaw the crisis since even US congressman Ron Paul saw this crisis and along with Dr. Marc Faber, Jim Rogers, Stephen Roach, Nouriel Roubini, Gerald Celente, George Soros and many more (this includes us) especially the underappreciated Austrian School of Economics.

The point is mainstream economics and financial models have failed miserably.

In a world where inflationary forces are fast becoming the dominant factors in asset pricing dynamics, traditional fundamentalism have been ineffective in keeping apace with the underlying structural changes in the risk equation.

So the mainstream can dream about the financial fiction of PE, Book Values, or etc… when money printing bubble cycles are becoming the chief dynamic in pricing stock markets as well as in the other asset markets.

Sectoral Performance In US, China And The Philippines

``[Asia is] a very different dynamic compared with the rest of the world. Most banking systems in Asia are flush with liquidity as they have a surplus of deposits over lending. So if [corporates] have in the past financed in the international bond markets, when it comes to refinancing they can turn to the local market alternatives because plenty of banks are still willing to lend”- Jason Rogers, a credit analyst at Barclays Capital Asia-Pacific corporate bonds surge

In bubble cycles, the object of a speculative bubble, after a bust, normally takes years to recover.

To cite a few, the Philippine Phisix following the 1997 Asian Crisis episode hasn’t fully recovered even 12 years after, Japan’s Nikkei 225 and its property sector remains in doldrums following the bust in 1990 (that’s 19 years!), and the technology centered dot,com bust during the new millennium in the US has left the Nasdaq miles away from its peak, 9 years ago.

The recent bubble cycle phenomenon evolved around the US real estate sector which had been funded by the financial industry. In short, these two sectors-financials and real estate accounted for as the epicenter of the bubble cycle crisis. So given the nature of bubble cycles, I originally expected the same dynamics to unfold.

The fundamental reason for this is due to the market clearing process or the process of liquidating clusters of malinvestments acquired during the bubble.

And since bubble blowing or the “boom” phase is a process underpinned by policies that is cultured by the markets over time, the liquidation or the “bust” phase likewise employs the same time consuming process but in reverse.

But I guess this dynamic doesn’t seem to be the case today or put differently, this time looks different.

Why?

Because US money managers have largely been overweighting the financial sector, see Figure 5.

Figure 5: Bespoke Invest: Institutional Sector Weightings

According to Bespoke Invest, ``money managers collectively have 18.5% of their long portfolios in the Financial sector, which is the highest weighting for any sector. Technology ranks second at 16.8%, followed by Health Care (12.9%), Energy (12%), and Industrials (10.3%).

``The second chart compares these weightings with the sector weightings of the S&P 500. As shown, institutions are overweight the Financial sector the most and underweight Consumer Staples the most.”

Obviously, the enormous backstop provided for by the US government to the US financial sector has circumvented the natural process of liquidations from fully occurring.

Hence, the intriguing outperformance led by the money managers piling into a sector under the government “umbrella” to seek profits or “economic rent”.

Yet, despite such outperformance, government intrusion to the industry will likely result to more systemic distortions.

To quote Professor Mario Rizzo in a recent paper ``These are agents whose discretionary behavior, insulated from the normal discipline of profit and loss, can significantly affect the course of economic effects. Thus, discretionary behavior on the part of monetary authorities (the Fed), fiscal policy makers (Congress or the Executive), or even in some cases private monopolists, can increase uncertainty faced by most economic agents (“small players”). They will have to pay more attention to trying to guess the perhaps idiosyncratic behavior of the big players. Economic variables will become contaminated with big-player influence. It will become more difficult to extract knowledge of fundamentals from actual market prices.”

Again, pricing signals are becoming less efficient due to government intervention (more difficult to extract knowledge of fundamentals from actual market prices) and is likely to heighten systemic risks (can increase uncertainty faced by most economic agents) arising from the asymmetric behavior of the industry participants shaped by regulators (insulated from the normal discipline of profit and loss).

In combination with the toxic assets stacked in the bank balance sheets, I would remain a skeptic over US financials.

Interesting Parallels In China And The US, Possible Opportunities

It is interesting to see how some parallels can be gleaned from the institutional interest in US stocks and in China’s recent sectoral performance.

While Financials, Materials, Consumer Cyclicals, Energy and Industrial outperformed the S & P 500, in China, Energy, Materials, Financials, Technology and Industrials constituted the top 5 during the latest run on a year to date basis, see figure 6.

Figure 6: Bespoke Invest: China’s Sectoral Performance

In other words, except for Consumer Cyclicals in the US and Technology sector in China, there seems to be some common interests from respective domestic investors-energy, materials, financials and industrials.

In the Philippines, the top 3 sectors have been Mining and Oil, Industrial (energy) and holding companies, whereas financials and services (telecoms) have been laggards.

Except for the financials, basically we see the same pattern playing out.

More interesting insights from Bespoke Invest, ``Sector performance in China paints an interesting picture. In typical selloffs, sectors that lead the rally see the steepest declines, while laggards in the rally tend to outperform. In this selloff, however, this trend is much less evident. The chart below shows the average performance of Chinese stocks by sector during the rally and since the peak on 8/4. While Energy led the rally and has seen the sharpest decline, in other sectors the relationship has been much less evident. For example, Utilities and Telecom Services were in the bottom four in terms of performance during the rally, but during the decline they have also been among the weakest sectors with the second and third worst performance.” (emphasis added)

Given the degree of corrections, it appears that China’s financials are on the way to outperform but could still play second fiddle to Energy.

So while I would remain a skeptic over US financials, it’s a different story for China and for Asia.

Nonetheless if we follow Dennis Gartman’s 7^th rule of his 22 trading rules, ``Sell markets that show the greatest weakness, and buy those that show the greatest strength. Metaphorically, when bearish, throw your rocks into the wettest paper sack, for they break most readily. In bull markets, we need to ride upon the strongest winds... they shall carry us higher than shall lesser ones”, then this would imply that energy, materials and financials could be the best performing sectors over the coming years and could be the most conducive place to be in to achieve ALPHA.

That’s also because China has aggressively been bidding up global resource and energy stocks, for reasons we cited in China's Strategic Resource Accumulation Continues.

Finally, this brings up a possible “window of opportunity” arbitrage for the Philippine markets. Since the local financials have severely lagged the recent rally and IF the same US-China patterns would play out sometime in the future, then positioning on financials on market weakness looks likely a feasible trade.

In addition, the underperformance of the telecom sector which has patently diverged with technology issues has piqued my interest and could be a point of discussion for another day.

Food Crisis Watch: Sugar On Fire- Writing On The Wall?

Sugar prices have been on fire.

According to the Economist, ``THE price of sugar is higher than at any point in 27 years, having risen much more than prices of other food in recent months. The cause appears to be a huge drop in sugar production in India, the world's second-largest producer. In the 2007-08 season India's output was 28.6m tonnes of sugar, but this year production is estimated to fall to 16m tonnes. Indian farmers planted less sugarcane last year after sugar prices fell, partly in response to a ban on exports. A weak monsoon also threatens this year's production. Indians are also the biggest consumers of the sweet stuff: in 2008, they used 24.3m tonnes, nearly 15% of global demand. A decline in Indian production means that it will import more, driving up international prices. India's government has lifted its export ban, but production is unlikely to meet demand before 2011."

So the unintended effects from government policies to curb exports and weather appears to be the "seen" culprit.

But as you would probably notice, the Economist food price index have likewise been creeping higher but at a much subdued clip relative to sugar prices.

I would add that sugar's accelerated price movement came about as stock markets globally surged. This implies of some correlation-loose monetary environment plus fiscal policies may have likely been principal factors too.

Nonetheless here is Jim Roger's take on sugar.(emphasis added)

``Sugar –even though it is at a 28 year highs, you would probably know it is down 70% from its all time high. So sugar is still very depressed on any kind of historic basis and I suspect it will go higher. The last time we had a bull market in sugar in 70s, if you would remember there was no biofuel - that is a huge new element of demand now and most of Asia was not involved in the sugar market in any big way back in the 70s. But now Asia is prospering and there are 3 billion people trying to have a better life and most people when they get more prosperous, use more sweets. So you have big elements of demand in sugar now that you did not have in the last bull market. I wouldn’t sell sugar, I don’t know if it is going to go up in the next week or the next month but I am certainly expecting sugar to go much higher during the course of the bull market over the next several years.

It won't be just sugar though...

Jim Rogers anew, ``food inventories are at the lowest they have been in decades – not lowest in months or years but in decades. There is a very good chance that we are going very serious explosions in the price of food because we may have no food at any price if we continue to have weather problems. Yes you are having some monsoon problems in India but the rest of the world still hasn’t had bad weather. If we start having serious weather problems around the world as we have had many times in history, the price of food is going to skyrocket because there are no inventories and there is no productive capacity."

Ergo, The price spike in sugar could be the proverbial "shot across the bow".

As we noted in Chart: Global Food Price Inflation

``Many factors that gives rise to these disparities, aside from monetary and fiscal policies (taxes, tariffs, subsidies, etc...), there are considerations of the conditions of infrastructure, capital structure, logistics/distribution, markets, arable lands, water, soil fertility, technology, productivity, economic structure and etc.

``Our concern is given the present "benign state of inflation", some developing countries have already been experiencing high food prices, what more if inflation gets a deeper traction globally? Could this be an ominous sign of food crisis perhaps?"

Onion News Network: Wipe Out National Debt Through A Staged Coup

From the Onion News Network (Hat tip: Investment Postcards)

U.S. Government Stages Fake Coup To Wipe Out National Debt

Mark Mobius: Expect Market Volatility, But Capitalize On The Opportunity

From Franklin Templeton's July Emerging Markets Review

Feature of the Month: Q&A on Emerging Markets with Mark Mobius, Executive Chairman, Templeton Asset Management Ltd. (red highlights mine)

Is the recent rally in emerging market equities sustainable?

Although we are optimistic about the markets’ upside potential, it is important to realize that volatility is still with us and will be with us for a while. This means that there will be down markets as well as up markets. We therefore must pay attention to valuations and long-term earnings growth prospects in order to avoid buying or holding expensive stocks as a result of dramatic price rises that we have seen. Current valuations are below the five-year high valuations and thus are not excessive.

Emerging market equity funds resumed net inflows, recording a record $26.5 billion of investment in the 2nd quarter. Do you think emerging markets will continue to attract inflows?

In general, we expect inflows to continue, however, there could also be some volatility. We cannot expect to see net inflows every month or every week, but in general the trend should be positive. In the first seven months of 2009, net inflows (using weekly data from www.emergingportfolio.com) totaled US$34.5 billion. This is more than 85% of the approximate US$40 billion in outflows in 2008.

What are the reasons?

A return of confidence in emerging markets, the desire for higher returns, an increase in investor risk appetite, the search for undervalued companies and most importantly, attractive valuations in emerging market companies drove the inflows.

Within the emerging markets universe, where do you see the most attractive opportunities at this juncture?

Since it’s usually possible to find at least a few bargains in most markets, all emerging market regions are looking exciting. Currently, our largest exposures are to Brazil, Russia, China, India and South Africa. In terms of sectors, commodity stocks also look good because some of them have declined significantly below their intrinsic worth and we expect the global demand for commodities to continue its long-term growth. Consumer stocks are also favored. With rising per capita income and strong demand for consumer and other goods, the earnings growth outlook for these stocks is positive.

The World Bank recently said that reduced capital inflows from exports, remittances and foreign direct investment means “increasingly grave economic prospects” for developing nations. Do you share the view and is it something to worry about?

The World Bank is normally "behind the curve" when it comes to economic projections. Economists tend to look through the rear view mirror and not ahead. While reduced capital inflows from exports, remittances and foreign direct investment could have a negative impact on emerging markets, we can expect to see increased inflows resulting from consumer and infrastructure spending growth compensate for this. This could allow markets to record positive economic growth. This is especially the case in markets such as China and India.

Are you still optimistic about Asia ex-Japan? Which markets are you most positive about?

Yes, Asia is the largest emerging market region in the world. Asian countries are also growing relatively fast. They include countries like China and India with very large populations whose per capita income is growing, and capital markets in those countries are undergoing rapid development. Economic growth remains relatively high, per capita incomes have been rising, valuations remain attractive and reforms continue, thus improving the region’s business and investment environment. Our largest exposures are to China, India, South Korea and Thailand.

What are your views on the BRICs bloc? Is it a good investment proposition?

Yes, we remain optimistic about the long-term future of the BRIC markets. The BRIC countries are among the fastest growing economies in the world. Moreover, foreign exchange reserves in all four countries remain high. The four markets together account for more than 40% of the world population. Domestic demand growth also remains robust. China and India continue to register significant positive GDP growth rates in spite of the global slowdown China continues to take great strides towards becoming a major global player. The Chinese economy is expected to grow about 8% in 2009 and its foreign reserves have surpassed US$2 trillion. Moreover, Brazil and Russia are resource rich countries and although commodity prices have declined from their peak, the longer trend for commodity prices is up and these countries will benefit from global demand for oil, steel, aluminum, pulp, and other commodities.

Commodity prices have rebounded strongly and this has augured well for emerging markets. What are your views on commodities going forward?

The outlook for commodities remains positive. Strong demand from emerging markets coupled a more inelastic supply could lead to higher prices in the future. In general, we expect commodity prices to maintain a long-term uptrend. However, this will not be without corrections along the way. A number of emerging markets are major suppliers of various commodities as well as big consumers. For example, Brazil is one of the world's largest suppliers of iron ore, Russia is the largest supplier of natural gas, and so forth. Also, since emerging markets have the most people in the world the potential demand for commodities in those countries is also great. It is no surprise therefore that interest in such commodities is important..

I'd like to add that Dr. Mobius recently reemphasized the volatility factor.

According to Bloomberg (bold highlights mine), “When you have these rapid increases, almost without correction, you will definitely have a correction at some point, so we can expect a lot of volatility,” Mobius, the executive chairman of Templeton Asset Management Ltd., said in an interview in Kuala Lumpur today. “Increases of 70 percent can be followed by decreases of 20 to 30 percent.”

The so-called correction “can happen anytime, probably this year,” Mobius said. “It may not be all at once, you may not see a decrease of 20 percent suddenly, it could be 10 percent here, and a rise of 5 percent then another 10 percent, you’ll see this kind of volatility in the markets.” He added that he was referring to shares “globally.”

Nonetheless he would use the correction to add positions...

Again from Bloomberg, ``The biggest risk for global stocks is the increase in initial share sales and bond issues, Mobius said today. Investors will be “selling to take up new stocks, that will impact the prices,” he said. Mobius, who oversees about $25 billion, on July 29 said he plans to double Templeton Asset Management’s emerging-market assets within two years."

Since he doesn't think its a bubble...

Again from Bloomberg, “I don’t think it’s a bubble” because “you don’t have the irrational exuberance so to speak that you would normally find in a bubble activity,” Mobius said. The government’s policies to rein in bank lending are a “good thing,” he said.

Nassim Taleb: We Are Probably Worst Off Than Before

Interesting discussion between Nassim Taleb and Nouriel Roubini on Ben Bernanke at the CNBC.

Mr. Taleb avoids directly confronting Mr. Roubini, but runs an argument against policies undertaken by Bernanke from which Mr. Roubini supports. Nevertheless, Mr. Taleb in pun notes that Mr. Roubini's weakness is that "he likes Bernanke too much".

Here is Henry Blodget's summary of the interview:

-We're all in denial
-We're replacing private debt with public debt.
-We're not dealing with the cancer in our banking system.
-We're not making the structural changes we need to make.
-We're not being aggressive enough about restructuring debt (debt for equity swaps).
-Bernanke is a wimpy Greenspan sycophant
-Obama's rewarding the fools who got us here (Summers, Bernanke, Geithner)
The banksters are taking over again

Marc Faber: A Period Of Recovering Dollar And A Correction In Asset Markets

Marc Faber interviewed at CNBC with Nouriel Roubini

Some excerpts from Dr. Faber:

A period of recovering dollar and a correction in asset markets.

Because strong dollar means global liquidity is tightening

US least cyclical economy.

Emerging markets are more cyclical…they are like warrants on the US economy

In a scenario where growth will be disappointing…emerging markets are kind of vulnerable. They also became the favorite investment destination by momentum players

The worse the global economy, the more stocks could go up because the world’s central bankers have become nothing more than money printers.

They’re dangerous to the health of the global economy.

They created the Nasdaq bubble, the housing bubble, and now they want to create another bubble to bail them out.

Total breakdown of the system is ahead of us and it will devastate the global economy.

For the central bankers of this world and in particular Mr. Greenspan and Mr. Bernanke, the market mechanism is alright as long as prices go up, except for crude oil. That they object. But when it goes down that they feel they have to intervene.