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China Bull Versus China Bear - There Can Only Be One Winner
Monday, 25 February 2013 – Melbourne, Australia
By Dr. Alex Cowie
China Bull Versus China Bear - There Can Only Be One Winner
Why Italy Will Force the Next Move in the Currency War
Is Hyperinflation Heading Our Way?
In today's Money Morning:...how China will fire up demand for natural resources...why mining stocks are a great opportunity in 2013...words of advice from a retired hedge fund manager...why the euro will weaken...

China Bull Versus China Bear - There Can Only Be One Winner

No punches have been thrown in the office...yet.

It might not be long though. This China bull is taking on the office's most devout China bear, Greg Canavan, in a war of words that's on the verge of getting out of hand.

One of our colleagues suggested we dress up in bull and bear outfits, and just have it out on the streets here in St Kilda. He helped support his idea with some photo-shopped pictures of yours truly and Greg:



Source: Ninjali Design

What do you reckon?

Funny thing is, fighting in fluffy animal costumes in the streets of St Kilda actually wouldn't raise many eyebrows. In fact, we'd probably make some money from hipster passers-by for our 'street performance'.

But looking past the cute pictures, I want to emphasise that there's a serious message here.

This starkly divided opinion in this usually united office is symptomatic of something - China is at a critical crossroads.

This is of paramount importance because which way China turns makes now either time to sell resource stocks and run for the hills as Greg instructs; or as I believe, it makes right now the best time in more than five years to buy resource stocks...


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China bears are a bit overconfident right now, after having loads of mud to sling at us for the last two years.

You see, since the start of 2011, China's growth decelerated steadily from 9.8% down to 7.4%.

'Crashing Chinese growth' has been the China bears battle cry!

Trouble is that neatly overlooks the fact that 7.4% is still a nitrous-oxide type growth rate!

To put 7.4% in context, it doubles an economy's size inside of a decade. It's fast. It also makes China's growth by far the fastest growth rate in any large country globally. You have to start looking at tiddlers like Thailand (twenty times smaller than China) to find faster growth.

But it was the deceleration of growth that has the bears fired up. Would it continue and take China down in flames?

Short answer: no.


Bullish on China: Here's Why

Over the last few months of 2012 (as far as I could see) it was obvious China was building for a solid bounce in economic growth. It was time to get bullish on industrial commodity stocks again. That's why I started 2013 with a copper producer for Diggers and Drillers readers.

Sure enough, when China released its GDP data a week later, it showed a meaningful jump from 7.4% to 7.9% growth.


China's Growth on the Way Back Up Again - Copper, Iron Ore and
Coal to Boom




Of course, one stubby does not a slab make. We need a few more quarters to confirm this trend. But by then, the trading opportunity will be gone, so where do we look?

The 'Purchasing Managers Indices (PMI)' are one place.

Between the official and HSBC versions of this index, they survey 1250 'purchasing managers' in the Chinese manufacturing sector. Businesses react to the market rapidly, and the purchasing manager has the best view and feel of the economic conditions.

It's a 'leading indicator' of the economy. As such, it's usually a pretty reliable guide of what the GDP will be for the quarter. And right now the PMI's have been in positive territory for their last four monthly releases.

Of course, the only problem with trading on an official PMI, or GDP figure, is that they are government statistics. And as they say, there are lies, damn lies, and government statistics. Thing is there's also an even worse category, called Chinese government statistics. So we watch them, but take them with a pinch of salt or three.

But if Greg pinned me down to give him one reason why I was so bullish on China at this moment, it actually wouldn't be the statistics.

The reason would be that in November 2012 China wrapped up the main parts of its once-in-a-decade leadership transition.

In short, this will be one of the major drivers of the commodity markets in 2013.

In my eyes, it's an investing opportunity that you can either grab now, or kick yourself for at Christmas for missing the trade of the year.

The reason I say this is that, like clockwork, this leadership transition has unleashed a wave of infrastructure spending. This chart shows how this has jumped EVERY time in the last thirty years. The years after 1982, 1992, and 2002 ALL saw a huge move without fail.


Buckle Up for Huge Chinese Spending



Source: FT

The reason being that Chinese politicians have their hands tied until the transition passes, so once it's in the bag, they play catch up on projects. Besides, they are smack in the middle of an ambitious five-year plan of spending targets and they need to pick up the pace to get there.

So I expected a dam-burst of infrastructure spending to be unleashed in early 2013. And that would drive commodity demand as project development growth moves up the gears again.

We had a clear signal of this in China's credit figures for January.

After treading water for most of last year waiting for the leadership transition, the flood gates of lending have opened.

The 'total social financing aggregate', which is China's most comprehensive measure of lending, has jumped from around one trillion Yuan a month, to 2.5 trillion a month.


China's Lending Explodes: Total Social Financing
Aggregate Soars to 2.5 trillion



Source: Bloomberg

Now China bears will probably be tearing their hair out at this point. Their beef is that this is a clear warning sign of a credit bubble.

This is the core of where the bulls and bears differ. Where the bears see this lending as a reason to run and take cover, I see it as a precursor to immense Chinese growth.

To me, the crux of this chart is that this lending will translate straight into demand for the raw ingredients of an economy: iron ore, copper, coking coal, and the scores of more obscure raw ingredients like manganese, tin or rhodium. Not to mention indirectly to demand for gold - one of the things Greg and I can agree on.


Some Words of Wisdom

But what about the idea that I'm overlooking the fact that half of China's GDP figure is from lending what could become bad loans that will cripple the banking sector?

There's no denying China has taken investment spending to nosebleed levels, and that it will need to unleash the value for the bets to pay off. But I'm more optimistic than the China bears on this happening, and thus preventing non performing loans from rocking the system.

And I'm also more optimistic on China's ability to stretch and rewrite the rules to enable payment, and to use the raw power of urbanisation and also rising land prices to pay off debts. But that's a story for tomorrow's Money Morning.

In the meantime, don't forget to check out our free Google plus pages. We've already served up a few exchanges on the bull and bear China debate. Check it out.

And even if I'm wrong on all counts, you can be very comfortable that even if a credit bubble bursts - China will pull rabbit after rabbit out of the hat to delay it.

I'm not denying that the China bears could even get it right in the end. We'll see. In the meantime, investors have any number of years in which to make money from the resource sector as this young resource rally builds steam again after its two-year sell off.

A hugely successful retired fund manager summed it up for me recently by saying, 'Any punter on the street can always tell you twenty reasons to avoid the market - the trick is to spot the opportunities amongst the chaos, and then nimbly monetise them while the bears tie themselves up with thoughts of impending doom.'

Enough said.

Dr Alex Cowie
Editor, Diggers & Drillers

From the Port Phillip Publishing Library

Special Report: The Gold Mirror of Kaieteur Falls

Daily Reckoning: The Domino Line Approaches the Australian Economy

Money Morning: The Gold Bull Market: Nothing Goes Up in a Straight Line

Pursuit of Happiness: New Technology: Etched in Glass


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Why Italy Will Force the Next Move in the Currency War
By Matthew Partridge, Contributing Writer, Money Morning

It's safe to say that there aren't many politicians with the staying power of Silvio Berlusconi. Less than four months ago, he was sentenced to a year in jail for tax fraud. And he still faces other criminal charges. Yet the polls still suggest that there's an astonishingly good chance that the former prime minister will actually win next week's election in Italy.

This is clearly amusing in its own way - given how many people breathed a sigh of relief when it looked like jail might be the end of 'bunga bunga Berlusconi' as a political force. But it also comes with some very unfunny implications.

Everyone knows that Berlusconi isn't that into either the European Union or into the austerity apparently required to keep it together. So, as his poll ratings are surging, so are Italian bond yields: they have hit levels not seen since the end of last year. That's not a good thing.


The End of Monti's Dreams

Back in November 2011, it looked as if Italy - with its huge deficits and clear unwillingness to reform - was on its way out of the euro. To make it possible to 'save' Italy, Brussels made it clear that Berlusconi had to go. He did. And in his place came the technocrat and Brussels man Mario Monti, a former commissioner.

The idea was that his non-partisan status and close relationship with Brussels would help him pass reforms, cut spending and stop Italy being the catalyst for European collapse.

This was undemocratic stuff (which is also not a good thing). So, at the time, Monti promised that he was nothing but a concerned caretaker - one who had no intention of running for re-election. In reality, there were hopes that the major parties would allow him to stay on as prime minister without having to face voters.

Things got off to an adequate start. There was much PR put out about the basic strength of Italy (and it is true by the way, that the average Italian household is less stretched than, say, the average Spanish household).

And there was some small success in pushing business and labour-market reform. However, along with reform came tax rises and rising unemployment. That didn't go down well at all. The result? A new movement - 'Five Star' - surged in the polls demanding an end to austerity. It became clear that Mr Monti was not going to be re-elected by default.

That was clearly disappointing for him. Once you have had a taste of power, it is tough to give it up. So at the end of last year, Monti changed his mind and decided to run for office as part of a group of parties called 'With Monti in Italy'.

It isn't going that well. Polls currently show their support running at around 13%. That puts them fourth. And the candidates in first, second and third place? They are all anti-austerity.


Italy Has a Long Way to Go

The obvious take away from this is that, even if Berlusconi himself doesn't win, the next government isn't going to be doing what Brussels wants it to.

That sounds bad but the truth is that even if a new government wanted to stick with the status quo, it's hard to see how it could. Without real inflation or external devaluation to speed the process up, the pace of change is simply too slow.

Take wages. To be able to compete with Germany, Italy needs to cut its unit labour costs. However, relying on firms to directly cut wages has had little effect. While Italian wages are now coming down, they are only doing so slowly.

Italy is still less competitive than Greece, Ireland and Spain - so much so that Capital Economics reckons wages will need to fall by a further 15% to 20% for the crisis to be of much use to Italy's corporate sector.


The Big Choice Ahead

The key point is that the next Italian government is going to be neither willing nor able to dabble in austerity and reform while waiting for things to resolve themselves. So what's going to happen?

You might think the best thing would be for Italy to get on and leave the euro. A new lira would fall in value and that would cut real wages via imported inflation. Italy would be competitive, exports would rise, debt would fall. Job done.

If only it were so easy. After all, were this simply a question of economics, the euro would be long dead. The more likely solution is another attempt to smooth over the cracks with more quantitative easing (QE) from Brussels.

We have long predicted that, when push comes to shove (as it often seems to these days), the European Central Bank (ECB) is willing to do anything to keep the single currency together. So far, that's been the correct assumption to make.

In any case, world events are also forcing Mario Draghi's hand. Japan's new inflation target, the Fed's open-ended QE and the decision to appoint Mark Carney as head of the Bank of England, risks leaving Brussels with an overvalued euro - Robert Jukes, global strategist at Collins Stewart Wealth Management, thinks that the euro is overpriced against the dollar by not far off 20%.

This means that unless the ECB wants exports to collapse (something Germany's many manufacturers clearly don't fancy), it is going to have to throw itself into the currency wars.

So how should you play this? QE is good for equities (albeit in a bad way) and falling currencies are good for equities too. So the best way is probably the usual way - buy into Europe's stock markets.

Matthew Partridge
Contributing Writer, Money Morning

Publisher's Note: This article originally appeared in MoneyWeek


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Is Hyperinflation Heading Our Way?
By Merryn Somerset Webb, Contributing Editor, Money Morning

Back in 2008, some 80% of people living in Zimbabwe replied 'yes' when asked if there had been times in the last twelve months when 'you did not have enough money to buy food that you or your family needed.'
That was just one of the deeply unpleasant consequences of Robert Mugabe's shockingly awful economic policies and the hyperinflationary meltdown they resulted in.

As some of the world's biggest countries continue to print money, the question is could we be heading the same way?


Did We Learn Anything from Zimbabwe?

Things are better now in Zimbabwe. In 2009, the local currency (by then denominated in trillions) was abolished, the US dollar took over as the most used currency, and by 2011, a miserable but improved number of people (39%) said they were going hungry.

But even as Zimbabwe's economy slowly pulls itself together, a good many people in the West think we have been too slow to learn the lessons it should have been teaching. I have several worthless Zimbabwean bank notes. I also have several left over from the miseries of the Weimar Republic.

They've all been generously given to me by people who think that the current rounds of money printing in the US, the UK, Japan and Europe will eventually lead to very high (and then to hyper-) inflation (hyperinflation being officially defined as price rises of 50% plus a month).

Maybe we have nothing to fear.

James Montier of GMO - a strategist we have a lot of time for - thinks these people are nuts. Why? Because a huge rise in the money supply is not enough to cause hyperinflation.

The basic theory of monetary hyperinflation suggests that it tends to start with a government with a deficit. That government then prints money to keep its debts under control. Prices rise.

People lose confidence in money (it's important to bear in mind that money is simply a function of trust) and spend it as soon as they get it. The velocity of money rises. Prices rise. The velocity of money rises again. And so on and so on.

But as far as Montier is concerned (if I understand him correctly), a rising supply of money, while a necessary condition for hyperinflation is not in itself enough.

For that you need other things - a nasty supply shock (Zimbabwe had this with the collapse of its agricultural sector), a high level of debt in a foreign currency, or a transmission mechanism that allows wages to rise faster than prices - indexation of wages to prices perhaps.

The point is that hyperinflation isn't just a monetary phenomenon - it needs social and economic stresses to really get it going. To think otherwise, says Montier, is 'bordering on the simple minded.'

I don't disagree with this. As I said here last year, stable countries with liberal and diverse political institutions should be capable of preventing monetary crises.


The West is Not as Stable as You Think

But the problem is that a good many of the countries we think of as being stable are nothing of the sort - or well on the way to becoming nothing of the sort.

There have been 57 properly documented hyperinflations since 1795, and the very fact that they can be officially proven rather suggests that they started in countries that were not far from having solid institutions filled with respectable number crunchers themselves (we have, of course, no idea how many undocumented hyperinflations there have been).

Take Europe. The brilliant Bernard Connolly's views on the extremism and social unrest that will bring Europe down are absolutely relevant.

As he points out, opposition to the euro 'has moved into the mainstream in Italy,' and if Silvio Berlusconi ends up the driving force behind the next government, it is very hard to see an end game that doesn't come with chaos.

Even Montier notes that if you were to worry about hyperinflation (which he doesn't), you might want to note that this is just the sort of thing that causes it: 'the collapse of the Austro-Hungarian Empire, Yugoslavia, and the Soviet Union all led to the emergence of hyperinflation!'


One Central Bank Has Given Up

It is also worth noting that while hyperinflation might not be top of our immediate forecast list for the UK, high inflation is.

The Bank of England is no longer even bothering to pretend that it is going to have a go at hitting its inflation target over the next few years - and that's even before Mark Carney (Albert Edwards suggests we call him 'Chopper Carney') has found a house to rent in London.

So, the pound is falling, inflation is rising (and will rise further given the hit the pound has taken in the last week) and no one is going to do anything about it.

Why? Because, despite the fact that falling real wages (prices are going up faster than earnings) and negative real interest rates (you get less in interest on your deposit account than you lose to inflation) are surely hitting consumption, and despite the fact that high inflation would destroy the gilt market, 'attempting to bring inflation back to target sooner would risk derailing the economy.'

So much for the idea that the Bank's principle objective is to maintain price stability.

Merryn Somerset Webb
Contributing Editor, Money Morning

Publisher's Note: This article originally appeared in MoneyWeek

From the Archives...

The Biggest Crisis to Hit the Stock Market Since the Last One
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My Wife and Warren Buffett
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How a Share Trader Approaches the Market
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The Two-Dimensional Diamond That's Set to Turn Your World Upside Down
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