Saturday, July 28, 2012

A peak may be in sight for commodity prices

When I was back in Australia everyone there told me about a two speed economy, fast driven by the commodity boom, and slow for everyone else. Well it looks like the fast will slow down and then Australia will be slow all over. Aivars Lode

Commodity prices
Downhill cycling

Jul 28th 2012 | from the print edition

ASSIGNING analysts to cover the humdrum world of commodities and mining was once investment banking’s punishment for low-flyers or copybookblotters. Then China’s pulsating economy and appetite for raw materials sent the prices of industrial metals and bulk commodities soaring. It turned watching the dismal world of copper, zinc and nickel, and the mining firms that dug them up, from a role tantamount to constructive dismissal to glamour.

Can it last? Signs that China’s economy is coming off the boil—recent figures put annual growth in the second quarter at a mere 7.6% compared with the double-digit rates of the past few years—have led some to suggest the commodity boom is over and prices are likely to crumble. That prognosis looks premature.

The past decade has been a remarkable one for metals and bulk commodities—iron ore and coal. Consumers, desperate to get their hands on raw materials, paid well over the cost of production as demand outstripped supply, which was constrained by years of underinvestment by mining firms. Many analysts talked of a “supercycle”, a long-term surge in prices lasting for decades on the back of Chinese demand.
In this section

    The Spanish patient
    Où est Monsieur Paulson?
    Unhappy birthday to you
    Taking stock
    The dismal dash
    Calories and currencies
    »Downhill cycling
    The Chicago question

Related topics

    Financial services
    Securities Services
    Investment banking
    Investment services

Chinese urbanisation has been the fundamental force behind that demand. Until the start of the millenium China, the world’s biggest producer of many commodities, was largely self-sufficient or even a modest exporter. Economic reforms have turned it into a manufacturing and exporting behemoth, and have prompted a vast movement of people away from the countryside to the cavernous factories and sprawling megacities of the new China. The housing, roads, railways and infrastructure supporting this shift required massive imports of minerals.

China’s steel production grew by 16% a year between 2000 and 2011. Around half the world’s steelmaking raw materials and two-fifths of its copper and aluminium now disappear down the dragon’s maw. The price of copper, which had fallen by 0.8% a year in the 1980s and 1990s to reach little more than $1,300 a tonne a decade ago, exceeded $10,000 a tonne in early 2011 and still stands at around $7,500.

A slowdown in China has led people to wonder whether the supercycle is over. The evidence suggests that it has reached a peak. Academics probing supercycles over the past 150 years reckon that the expansionary phase lasts between 15 and 20 years. Most analysts put the start of the most recent cycle around 2000 (see chart 1). HSBC, which thinks this cycle is just seven years old, concedes it faces the onset of “creaking middle age” and that a long senescence might follow. Ruchir Sharma of Morgan Stanley sees in a 200-year history of commodity prices a repeated trend of two decades of price declines followed by one decade of gains.

Commodity bulls and the world’s big mining companies have an answer to all this. They reckon that China still has far to go in building the cities, motorways and airports it needs. Marius Kloppers, the boss of BHP Billiton, the world’s biggest miner, points out that 200m Chinese swapped village for city between 2000 and 2010; he expects another 250m to follow over the next 15 years.

Copper-bottomed boom

Even the bulls accept that demand for copper and steel tends to level off in the later stages of a country’s economic development. They just reckon that China is not there yet. They brandish charts of “metal intensity”—consumption of commodities measured against GDP per head. By this measure China still lags far behind richer countries such as South Korea and America for copper (see chart 2) and most other commodities. The theory is that China should be expected to catch up rapidly, with South Korea at least.

Too simplistic, say analysts convinced that the supercycle is about to freewheel downhill. Nomura, a bank, observes that this measure ignores China’s high level of investment relative to GDP. Figures on per capita consumption are only part of the story; China’s vast population means the country already consumes a huge amount of metal, making further bumper growth tricky. (In 2010 China used 577m tonnes of steel, compared with 91m tonnes in America.) Nomura calculates that in 2011 China used 104 tonnes to generate $1m of GDP, compared with 6.7 tonnes in America. The picture is similar for copper and aluminium: China’s economy cannot keep metal consumption growing at the current rates of about 5% a year.

More factors suggest that metal intensity might waver, according to UBS. Returns on fixed capital formation—buildings, roads, other infrastructure, plant and machinery—are waning. The bank says that a frenzy of investment after the credit crisis of 2008, when total bank loans doubled in three years, led to seven years of infrastructure spending in a mere three years. Many of the projects were either premature (subway stations standing lonely in bleak landscapes waiting for a town to arrive), not terribly productive (motorways in the hinterland rather than between the biggest cities) or not needed at all.

That investment splurge means that infrastructure spending may have peaked already. The upshot, according to Julien Garran of UBS, is that supply has now caught up with demand for coal and nickel, and will do so for copper next year and iron ore in 2014. Mining companies have spent heavily trying to adjust to China’s hunger for minerals. Citigroup says they are poised for more capital expenditure in the next five years than in the past 20 years combined. But if it is true that China’s appetite is less ravenous than expected, then investment will fall too. Big projects due to start in the next three years are locked in, but beyond that all are up for grabs.

Even if the supercycle is drawing to an end, China will still be a huge market with enormous influence over prices. But the sheen may be fading, as on a lump of steel left out in the rain.

Friday, July 27, 2012

In Defense of – Not That They Need Defending. Shrinking the NOW-Gap

 An interesting summary of Amazon as they continue to redefine the retail experience. Aivars Lode
    Posted by kid dynamite
    on July 27th, 2012

I don’t know how I can go about “defending” a stock that I don’t even own – I have no position in $AMZN, and never have – sadly.  Like so many of you, I’ve spent the better part of a DECADE now saying “it’s too expensive – I don’t want to own that stock,”  as it climbs and climbs and climbs.   Here’s the 5 year chart:

Today, I read a number of miffed comments on the Stocktwits stream about $AMZN’s stock rally on earnings that seemed mediocre.   I figured I’d put some thoughts to keyboard while the topic is fresh.

People seem confused/annoyed/angered by AMZN’s continued stock price ascent on mediocre net earnings per share numbers.  The story is about so much more than that though.   There have been a number of companies who have tried the “don’t worry about our profitability, we’re building a customer base and we’ll make up for it later in VOLUME” model.   I don’t think that disaster-in-the-making paradigm applies to AMZN at all:  the beauty of AMZN is that they’ve managed to grow into the most dominant force in the history of retailing WITHOUT accruing huge losses.   Have they “sacrificed” profitability to some extent?  Of course – their margins are small and not growing, but they don’t accelerate revenues via price sales or temporary mispricing of goods that lure customers in based on prices that will rise later (and send customers running for the exits at the same time) – the secret to Amazon’s success is that they’ve built a logistical empire that can get you what you want (and what you don’t even yet know you want) at speeds that continue to blur the line between brick and mortar and online fulfillment times.

What I mean by that statement is this:  if you need something NOW, you still can’t order it and get it in time.  They are continually working on shrinking that NOW-gap, though, and it’s gotten to the point where on Monday if I need something for Thursday, I have no qualms about ordering it from Amazon.   Their goal, I think, is to turn “Thursday” in my mind into Tuesday.   They’re not quite there yet, but they’re awfully close.   I’ve written numerous times about ordering something at 6pm and having it show up at 8:30 the next morning.  How?  I, quite literally, have absolutely no f*cking idea.  I live in rural New Hampshire, and I cannot fathom Amazon’s logistical genius, but I don’t care if they have a band of magical elves delivering the product to me from their Kentucky warehouse – as long as I get it, I’ll continue to be happy and amazed.

New York City residents might remember the internet bubble darling which allowed you to order something as small as a pint of ice cream and a pack of gum, and they’d bring it to you in a few hours.    Not surprisingly, that business model failed.  But Amazon is attempting to further blur that “I can’t order it online because I need it NOW” line by reducing shipping times to seemingly impossibly short intervals.  Will they get to same day?  I don’t know – but they might not need to.  Two day shipping is great, and next day shipping is almost NOW.

AMZN is a logistics company.   That’s something people tend to overlook.   Does AMZN need to spend billions building warehouses across the country to get me my stuff in even less time?  Maybe, maybe not – but the reason the stock doesn’t go down is because they are managing to do this cap-ex and STILL not put up big negative numbers.  They don’t try to convince you to say “don’t worry about these huge losses, we’ll make up for it in volume later” – instead, they make you say “holy crap – AMZN is already a logistical masterpiece – just imagine if they can make it even better, and NOT kill themselves financially in the process!  Then, once they stop growing, they just reap the windfall.”  At least that’s what they make me say.

So anyway, Amazon has built this logistical ninja model to get you what you want in a hurry, and the key is that they’ve managed to do while being profitable (or barely profitable, or barely unprofitable – but they’re not putting up huge losses).   Critics point to ridiculously high P/E multiples and miss the point:  when Amazon stops expanding their logistical empire, their customers won’t just click over toBuy.Com or some other website – the system still works, and once the cap-ex slows, the profits increase.   Once the infrastructure is in place, Amazon can continue to add more low-margin items.   They’ll happily sell you another $1000 worth of goods that they can only make $15 on – why not?   They want you to buy EVERYTHING from them.   I agree with the statement that CEO Jeff Bezos made in the earnings release yesterday:

“Amazon Prime is now the best bargain in the history of shopping – that is not hyperbole… We successfully launched Prime seven years ago with free unlimited two-day shipping on one million items. The price of annual membership was $79. Since then, Prime selection has grown to 15 million items. We’ve also added 18,000 movies and TV episodes available for unlimited streaming. And we’ve added the Kindle Owners’ Lending Library – borrow 170,000 books for free with no due dates – it even includes all seven Harry Potter books. What hasn’t changed since we launched Prime? The price. It’s still $79. We’re very grateful to our Prime members, and thank them whole-heartedly for the business and for the word-of-mouth that has made this program grow“

But the retail mastery – and make no mistake: Amazon has changed the retail landscape permanently – isn’t even the whole story.   Cloud computing, warehouse hosting, continued delivery advances (did you know that Amazon has delivery lockers in New York City, Seattle and D.C. for those people who don’t have doormen and have trouble receiving packages?) – it’s just getting better and easier.   They’re making it harder and harder for you to say “f*ck it, I really need this today – I’m gonna get in my car and drive to the store to get it.”

On Twitter today, the astute @Microfundy asked a crowd-sourced question to $AMZN bulls: “What would make you sell?”

I replied:

“no position, but I’d short $AMZN when someone shows they can offer any competition. right now, $AMZN is eating all of retail”

What I found even more interesting was a reply to my response, from @SteveZ1, who wrote that Amazon is:

“a cancer for other retailers. Can one up them if manufactures sold direct from one central fulfillment center. That’s next”

He didn’t realize that he’s making the Amazon bull case:  that IS next:  and that one central fulfillment center, as I noted in a reply, is called   Manufacturers pay Amazon to hold their goods in Amazon’s warehouse and to have Amazon handle the logistics of e-commerce (that’s what is happening when you see “sold by xxxx, fulfilled by” in the description).    Amazon IS the central fulfillment center: they are not about to get slaughtered by one!    @Trendrida replied with a story from this week about American Apparel making use of Amazon’s e-commerce platform.

Regular readers know that I’m a huge fan of Amazon as a consumer.  My wife and I place upwards of 100 orders a year on   Just this week, in the wake of our microburst, I used up the last of my 2-stroke engine oil that runs my chainsaw, weedwhacker, and leaf blower.   I had one last gallon of fuel that I’d mixed.  I knew I could order the oil I wanted on Amazon – I’d done it before – but I figured I’d stop into Lowes and pick some up while I was in town.   Guess what – Lowes didn’t have what I wanted, so I went home and ordered it on Amazon anyway – wondering to myself why I’d even bothered to waste my time at Lowes: I didn’t need the stuff today, after all.    It came less than 48 hours later, Amazon Prime, hand delivered to my doorstep.   Today I ordered a fertilizer spreader.   Where else would I buy one from?   No brainer.

Now I’ve written all of the above, but I still don’t own the stock.   Why?   I wish I had a good answer.  I don’t.  The best answer I have is that even after all of my “rationalization,”  AMZN isn’t “cheap.”   My point is that Amazon as a company is here to stay – that’s one of the first things I think about when I think about shorting a stock: could this company disappear?  With Amazon, I think that the answer is “no*,” and I think that they will eventually be able to reap the benefits of the logistical infrastructure empire that they have invested heavily in over the last decade.   Perhaps that means that they just “grow into” their current valuation – I have no idea: time will tell.

This also seems like the perfect time to emphasize that I am not suggesting that anyone buy $AMZN stock.  You’ll notice that I don’t really make stock recommendations on this blog.   What I’ve tried to do in this post is explain what I think is the bull case for Amazon.  If you’re sitting at home, reading the earnings report and shouting at your monitor “THEY ONLY MADE A PENNY A SHARE! HOW THE F*CK CAN THE STOCK BE UP MORE THAN 7%?”  well, I’ve attempted to offer one variety of explanation.

Sunday, July 22, 2012

CFTC’s Chilton Sees Silver Probe Concluding This Year

More instances of price manipulation in markets. Aivars Lode

By Silla Brush - Jul 22, 2012 9:00 PM PT
A four-year probe of potential price manipulation in the silver market may be completed as early as September, according to Bart Chilton, a member of the U.S. Commodity Futures Trading Commission.

“I am hopeful and expect the silver investigation to conclude in the not-too-distant future, hopefully in September or October,” Chilton, a 52-year-old Democrat, said in an e- mail. “It has already taken way too long.”

The enforcement division of the Washington-based agency, the main U.S. overseer of derivatives markets, began pursuing allegations of manipulation in the silver market in September 2008. Investigators have analyzed more than 100,000 documents and interviewed dozens of witnesses, the CFTC said in a November 2011 statement.

Chilton, who didn’t say whether the probe has uncovered evidence of manipulation, said previously that there had been “repeated attempts” to influence prices.

“There have been fraudulent efforts to persuade and deviously control that price,” he said at an October 2010 hearing in Washington“Any such violation of the law in this regard should be prosecuted.” 
Steve Adamske, a CFTC spokesman, didn’t immediately respond to an e-mail seeking comment on the status of the investigation sent outside of regular business hours.

‘Numerous Letters’

The agency concluded in a May 2008 report, before starting the investigation, that there was no evidence of manipulation in the market between 2005 and 2007. The CFTC, in the preceding two decades, had received “numerous letters, e-mails and phone calls from silver investors” alleging that silver futures on the New York Mercantile Exchange had been manipulated downward, according to the report. 

The CFTC was granted broader powers to pursue such cases under the Dodd-Frank Act. Commissioners last July completed rules making it easier to prove fraud and manipulation in markets for derivatives and commodities. 

The rules eased requirements that enforcement lawyers demonstrate that artificial prices were set and prove traders intentionally manipulated markets.
The new anti-manipulation rule requires the agency only to show that traders acted recklessly.