Credit Exhaustion and QExtreme

[The Machine]

 

A difficult pricing calculus for investors...

 

OVER IN China the meme of credit exhaustion is starting to spread, given that every CNY100 of reported GDP in the first quarter required the addition of CNY52 in new credit – much of that flooding back in from abroad to play the property boom, writes Sean Corrigan for the Cobden Centre.

 

That this is likely to lead to an implosion in fairly short order seems to have been recognised by the new men in charge. Hence the unusual convening of an April session of the Politburo Standing Committee for a meeting dedicated to the economy. From this there emanated an official press release containing the following injunction:

China needs to cement its domestic economic growth momentum and guard against potential risks in financial sectors

It doesn't sound as if another dash for growth is on the cards, now does it?

 

After the rout in the gold and silver market, all we can say is that though conspiracy theories inevitably abound, we have warned on numerous occasions that such a sell-off was always possible given the number of stale, trapped longs who have had no return for months while sitting at very elevated real and nominal valuations – and all in the face of ever-mounting equity rises, to boot. One may or may not care much for the idea of technicals as predictive tools, but, just once in a while, the break of an obvious trend line convinces those who do subscribe and gives rise to an avalanche of me-tooism and that was very much the case in gold and silver.

 

Since then everyone has come up with their own pet, Just So Story about what or who exactly triggered it. In all likelihood there was a multiplicity of overlapping causes, of which the two most important were probably:-

• the absence of a Risk Off spike on Cyprus (with added piquancy of possible forced reserve sale at the ECB's behest)
• the absence of an immediate inflationary rally on the BOJ move

More fundamentally, we have to face up to the fact that the Sell Side has simply l-o-v-e-d the fact that commodities are weakening while equities and credit are storming ahead since this enables it to spin a new tale to customers about why they should now revert to type and stick with their traditional, fee-generating asset classes.

 

Much has been made of the recent raft of negative reports from those who were formerly the bull market's greatest boosters, but in truth, as consummate salesmen, these worthies are only telling their disappointed customers what they already want to hear. No spiel sells as well as the one which allows an after-the-fact rationalization of an unlooked-for outcome. If you can't be smart about where the market is going, it at least assuages wounded pride (and patches up a tarnished professional reputation) to sound knowledgeable about where it has been.

 

All this has contributed to a poisonous mix of factors – fundamental, technical, and sentimental – among which we can include the following shifts.

 

Firstly, in terms of the guiding mantras which the crowd is so wont to adopt, 'Peak Oil' has given way to 'Shale Glut' and 'Super-Cycle' Chinese gluttony has been transmuted to an expression of faith in the all-seeing Confucian Mandarins who will shrewdly rebalance economy and unleash consumer spending, needing no copper in excess of the present quota to do so. (Big Mining itself has been reinforcing this shift, leading to the unusual result that Big Mining share prices are showing even worse returns than are commodities, despite the overall vogue for equities).

 

Next, financial momentum itself is now a killer, since the more commodities lag, the more people fear being left behind in any less than full commitment to the incipient equity bubble whose warm glow of instant mark-to-market gains they again avidly crave.

 

Again, given the appalling price action of late, the same trend chasers who did so much to boost commodities on the way up have been liquidating/shorting stuff and buying financial assets for some time, even before the gold/silver purgative. Their potential overstretch is our present best hope.

Finally, a glance at break-evens shows that inflation fears have dissipated, possibly in a very premature fashion. For our part, we have always argued that the central bank actions will be slow burners, as in the 1960s, until debt re-gearing and bank expansion again come to magnify solo CB pumping. It will be the inevitable reluctance to withdraw stimulus that will lead to catastrophe more than the initial decision to provide it and then, as monetary trust first falls and then is entirely lost, velocity will rise, CPI will accelerate, and real commodity prices will turn.

 

The widespread impatience with the inflationary argument arises partly because no one understands that for there to be ANY price rises, however CPI-modest, in a world awash in un(der)employment and surplus capacity, this can only be evidence of a deliberate monetary excess. Alas, for us, as investors, the fact that we understand the root of this error does not make its consequences any less significant for the pricing calculus with which we must contend or for the timescale over which we must deal with it.

 

Thus, QExtreme is now exclusively bidding up financial assets (the Herd comfort zone, as we have said) and real estate (the default for the Ordinary Joe). Yet all the while it is preventing a genuine re-invigoration by keeping zombie companies alive and bad governments in funds, thus depressing organic, vigorous 'growth' and so acting without immediately igniting an inflation which may well require a much longer gestation process than most are prepared to countenance. Not a great near-term mix for tangibles, it must be said.