Author Archives: Stuart Burns

For firms buying from suppliers in Europe, the rise of the Euro this year must have caused acute problems. Or, for those with contracts buying from European suppliers in dollars, those contracts will adjust sharply come renegotiation, as current exchange rates are applied to new contracts.

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The future direction of the world’s second-most-widely-used currency is of interest to many firms that directly or indirectly are a part of extended global supply chains.

Europe, too, is perplexed by the rise of the Euro. The dollar has declined relative to the Euro by more than 13% this year, driven by tensions with North Korea and dysfunction in Washington, according to The New York Times.

But investor appetite for the Euro has been fueled by more than tensions over North Korea.

Whereas the Euro is seen as a relative safe haven compared to the dollar, there is also a growing realization the Trump administration may not be able to deliver on tax reforms promised during his campaign at the end of last year. As a result, the relatively better-performing European markets may offer investment opportunities not previously available.

Nations Push Back Against Quantitative Easing

Many in northern Europe — Germany, in particular — are pushing for an end to quantitative easing (QE) for fear that it is stimulating asset bubbles.

The Telegraph reported comments by Deutsche Bank chief John Cryan last week saying property prices in advanced economies had hit record levels. In the same speech, Cryan urged European policymakers to start tapering relief of the Eurozone’s €60 billion ($72 billion) per month stimulus program sooner rather than later.

On the other hand, policymakers are worried about the impact of bringing money printing to an end and postponed a decision this month because of the recent weakness of the dollar. Any firm decision to taper or cease QE would result in the Euro strengthening further, potentially choking off Europe’s nascent recovery (during which growth has returned for the first time this year since the financial crisis).

Interest Rates Still Low

Inflation remains stubbornly low. At 1.5% last month, they show little prospect of hitting the 2% target this side of 2019, The New York Times reports.

The Federal Reserve began raising interest rates at the end of 2015, but the European Central Bank (ECB) is reluctant to do anything that could undermine what it still sees as a fragile recovery.

The absence of rising headline inflation figures to create an imperative — policymakers are largely turning a blind eye to asset price inflation for the time being, preferring to sweat over the rise in the Euro.

Indeed, Jörg Krämer, the chief economist at Commerzbank in Frankfurt, said as much in a recent note to clients, saying the pace of Euro strength is driving the ECB’s QE policy right now. Commerzbank is not expecting the Euro to continue to strengthen — and they may well be right.

If investors think there is a chance Congress will support the Trump administration’s tax reform that would allow businesses like Google and Apple to repatriate profits held overseas, the exchange rate landscape would transform overnight.

Half of what has been estimated as up to $1 trillion dollars is held in currencies other than U.S. dollars, so the demand for dollars would be immense, as would the boost to the U.S. economy if funds were repatriated and invested. Of course, that is the administration’s intent; for now, Washington seems in such a logjam that investors are discounting the prospects of such legislation being passed anytime soon.

The Euro, therefore, is being carried by its own relatively optimistic narrative: decent growth, low inflation and a sense of stability and, Brexit excepted, harmony not seen since the financial crisis. It’s hard to see the Euro weakening this year, but further direction may come in next month’s meeting of the ECB.

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MetalMiner is expecting any decision to taper QE to be kicked further down the road, putting a lid on further rises.

Euro strength is today’s problem, asset prices are tomorrow’s — that seems to be the order of the day.

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Mining stocks took a hammering last week, prompting questions as to whether the recent bull run in metal prices has come to an end.

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As steel and iron futures in China slid, share prices in iron ore and base metal miners were sold off around the world in a bearish wave of sentiment sparked, according to mining.com, by the continued appreciation of the Chinese currency against the U.S. dollar.

The Renminbi hit 6.447 against the dollar, gaining nearly 7.8% so far this year and a 21-month peak that appears to be worrying policymakers concerned about China’s export competitiveness.

According to the MetalMiner index, the Dalian exchange 62% Iron Ore settlement price closed at Yuan 534 per metric ton last week, down nearly 7%. Yet, steel demand remains robust in China and iron ore stocks that China’s port dropped for a fifth straight week according to commodity news, to 133 million tons the lowest since May. Indeed, because the currency is still appreciating, it is reported traders like to buy future cargoes in dollars, stockpile them and sell in Renminbi.

Investors Wary of Environmental Measures

One fear weighing on investors of mining stocks is China’s drive for environmental improvements, which is widely expected to result in the closure of steel mills, power plants, aluminum smelters and other sources of pollution (such as zinc and copper smelting).

According to the article, China plans to conduct 15 rounds of inspections during its new campaign starting this month and continuing until March of next year. Any plants that do not meet tougher environmental standards face closure. The resulting loss of production capacity, it is feared, will hit import demand for raw materials such as iron ore and bauxite.

Not surprisingly, iron ore spot prices declined toward the end of the week, but some are seeing current weakness as a natural correction to months of bullish strength.

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Physical demand remains strong, suggesting local traders are to frightened by Beijing’s environmental program just yet. Most are waiting for November, when the heating season starts and enforced closures are expected.

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Details are pretty sketchy at present, but a recent Reuters article sheds light on an investigation underway by Germany’s competition regulator into a suspected violation of antitrust laws in the steel industry.

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According to Reuters, the investigation expands an ongoing cartel office inquiry, which already covers makers and sellers of stainless steel, car manufacturers and suppliers, as well as companies in the forging sector.

The suspicion is of “anti-competitive collusion between companies” on flat steel products. Although not all steel firms are currently under investigation, many of the largest ones are.

Both ArcelorMittal and Salzgitter have confirmed units of their company have been searched in the first phase of an operation late last month that included seven companies and three private homes in Germany. According to the Reuters report, Manager Magazin reported that included in the investigation is the German Steel Federation, an industry association, although the publication did not cite any sources in its report.

Interestingly, any collusion may be limited. Kajor steel producer Thyssenkrupp and steel distributor trader Kloeckner & Co. both said they had not been searched, according to Reuters, nor is this part of a wider European Union action. Allegations appear to be restricted to several steel producers in Germany, although some of them, such as ArcelorMittal, are multinationals.

This week we covered the impact on the automotive industry of Hurricane Harvey and the likely boost to demand that will come from replacement of used and new vehicles damaged by the floods.

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Today we look at Harvey’s impact on the oil, natural gas and refining markets — not that you will need any reminding of the impact of Harvey if you have been into the gas station to refuel your car.

According to the Financial Times, the average retail price of petrol in the U.S. rose to $2.59 per gallon on Saturday, quoting to the American Automobile Association. That was up about 10% from its level the week before Harvey hit, and its highest level since August 2015 as refineries were taken out across southern Texas. Ten refineries in the region were still shut down on Saturday morning, according to the Financial Times, with a combined total of about 2.9 million barrels per day of refining capacity, representing a whopping 16% of the U.S. total, according to the Department of Energy.

The scale of the hit to U.S. supplies and the near instant spike in prices underlines just how reliant the U.S. is on the Gulf Coast for refining, refined product exports and LNG exports. Due to their location inland, primary production from shale resources in the Permian and Eagle Ford escaped damage and were back online as soon as wind speeds dropped, but lower-lying refineries were not so resilient.

This all goes to highlight a worrying exposure the U.S. has to this particular part of the world. Whether you believe in global warming, whether you accept climate change, whether you think it is all some left-wing plot is not the issue. The issue is Gulf crude production has more than doubled since 2005, leading a 75% nationwide increase, and now accounts for almost two-thirds of total U.S. crude production, up from 54% in 2005.

Yet while oil import dependency has plunged from 60% in 2005 to just 25% today, the refining of domestically produced oil has concentrated even more in the Gulf region.

Refining capacity in coastal Texas and Louisiana has, according to the Financial Times, increased by a quarter since the middle of the last decade, such that the region now handles half of all U.S. refining.

The U.S. isn’t the only one exposed to this one region. Rising total exports of refined products have left 90% of gross exports leaving from the Gulf region exposing neighbours in the region, who are reliant on U.S. supplies, to disruption in the event of a natural disaster — like a hurricane — or even a terrorist strike.

Some would argue that the flooding of southern Texas is less of a one-in-500-year occurrence than politicians would have us believe. The whole of the Mississippi delta is gradually sinking into the sea as levees built in the last century and canals built for oil extraction access prevent the river from depositing fresh silt and simultaneously allow the ingress of brackish water that kills off the vegetation once covering the area, the Economist reported last month. Storms and floods account for for almost three-fourths of weather-related disasters the Economist wrote this month and they are becoming more common.

Source: The Economist

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According to the insurer Munich Re, the Economist states that Harvey is the third 500-year flood to hit Houston since 1979. The U.S. may have little choice in the medium term than to continue its heavy reliance on Gulf-based refining and related infrastructure; if that is the case, then significant work needs to be done to better protect those facilities in the future.

Hurricane Harvey may have lashed Texas and Louisiana with 120 mph winds and record rainfall creating a disaster of near biblical proportions, but the Houston Automobile Dealers Association is already estimating the impact on the used car market.

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Quoted by CNBC, Stephen Wolf, chairman of the association, estimates that Harvey could have wrecked as many as half a million vehicles — resulting in, once the floodwaters recede and insurance companies pay out, a significant boost for the already robust used car market.

Houston alone is a top 10 market for new vehicle sales, according to Bloomberg, while the Houston metropolitan area ranks eighth nationwide in registered vehicles, with 5.6 million in operation prior to the storm. Bloomberg reports that more than 325,000 new vehicles were sold in the region during the last 12 months and as many as 130,000 new vehicles that were on dealer lots in the Houston area may have to be scrapped because of flood damage. Demand to replace dealers’ and owners’ lost vehicles would be a welcome boost to an industry that had seen its annualized selling rate drop to 16.4 million vehicles in August from 17.2 million a year earlier.

By way of a comparison, Reuters cites the experience of auto sales in New York following Hurricane Sandy in October 2012. The following month, auto sales rose 49% compared to the previous year, with all the replacement sales caused by the widespread flooding of the New York metropolitan area arising in the few months following the disaster.

Although all manufacturers could see an increase in demand for replacement vehicles, some brands are likely to benefit more than others.

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Australia is sometimes called “the lucky country.”

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Although the phrase is usually meant positively to reflect its bountiful natural resources (and sometimes to its isolation from conflict and strife elsewhere in the world), the original meaning was not so complimentary.

At the start of the last chapter of Donald Horne’s book “The Lucky Country,” a passage reads  “Australia is a lucky country run mainly by second rate people who share its luck. It lives on other people’s ideas, and, although its ordinary people are adaptable, most of its leaders (in all fields) so lack curiosity about the events that surround them that they are often taken by surprise.”

Personally, my experience of Australians has been very favorable: there is no one we like better beating at sports, they have a good sense of humor and are one of the few societies that have maintained a reasonable work-life balance.

But maybe part of that comes from those bountiful natural resources, much like Norway and a few other mature but resource-rich economies. The country is partially supported by exports of commodities they have in abundance. The Reserve Bank of Australia estimated in 2014 that household incomes across the country were 13% higher than they would have been without the mining boom and real wages were 6% higher.

Just like a Norway without oil and gas, without iron ore, coal, natural gas and other natural resources Australia’s economy would have to work a whole lot harder to just tread water.

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Several sources are leading on news that President Trump has twice rejected a Chinese proposal to cut steel overcapacity, despite the endorsement of some of his top advisors.

An agreement reached between U.S. Commerce Secretary Wilbur Ross and Chinese officials last month agreed a cut of 150 million tons per annum of capacity by 2022 was vetoed by the president, apparently because he preferred a more “disruptive strategy,” according to Reuters and the Financial Times.

The articles suggested the 22% rise in steel imports through July of this year compared to a year ago, reported by the American Iron and Steel Institute (AISI), spurred calls for action from U.S. steel producers to apply tariffs. Those calls may have influenced Trump’s position, as may the input of Steve Bannon, since fired, and Peter Navarro, an economic assistant to the president on trade matters.

The rejection of a deal brokered by Ross’ team seems to have undermined his position and probably leaves little room for further negotiation. The Chinese have gone away to consider their options, but rumors reported in the Financial Times suggest retaliatory action seems the most likely.

But while picking a fight with China probably makes for good headlines, at least as far as U.S. imports are concerned, is it the primary antagonist?

Not if you look at the AISI data.

Their findings suggest Taiwan and Turkey were the countries making up much of the increase. There was a sizeable increase from other countries, too, meaning Germany, up nearly 60%, and Brazil, up 80%, on three-month rolling average measures.

At 83,000 tons, China’s share of finished steel imports is a fraction of South Korea’s 352,000 tons, Turkey’s 245,000 tons or Japan and Germany’s about 138,000 tons.

Unless the administration plans on tackling these suppliers, picking out China seems a bit like fiddling while Rome burns.

We would hope that Trump’s presidency ends much better than Nero’s both for the man and the country, but picking fights that have a pragmatic strategy rather than catching headlines would be a good first step.

The abrupt rise in the aluminum price this month has caught many by surprise.

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Aluminum had been trading sideways for much of this year. Although the market was rife with rumors that China intended to close smelter capacity that was not carrying the required permits and approvals, most treated the prospect that such curtailments would be pursued with any rigor with some skepticism.

Past attempts to curtail excess production capacity among China’s manufacturing industry have been poorly pursued and often frustrated by local State governments keen on maintaining employment and tax revenues.

This time does genuinely seem to be different.

That realization finally set in when China Hongqiao, the world’s largest aluminum maker, confirmed it would cut annual capacity of 2.68 million metric tons, about 30% of its total, this month.

Following restrictions last month that the Shanghai Futures Exchange (SHFE) put on the trading of iron or steel futures by raising margins, speculators were looking for new investment opportunities just as concerns about aluminum supply became widespread. The rapid rise in the aluminum price, leading the Shanghai Futures Exchange to a six-year high, is now recent history.

According to the Financial Times, JP Morgan is forecasting that prices have another $100 per ton to rise in the fourth quarter, despite aluminum inventories in China more than quadrupling so far this year.

Although Beijing is following its policy of closing un-permitted production with considerable vigor, the resulting high prices are encouraging every smelter that has approvals to operate at 100% capacity. As a result, production has never been so high, with much of the surplus metal going into store.

Trade unions at producers outside of China who have been suffering by the flood of semi-finished Chinese aluminum exports called earlier this year for a global forum to address the issue. But before such a forum can be gathered, it seems likely that China’s high SHFE aluminum price may curtail exports as domestic mills struggle to compete internationally based on high-priced domestic primary aluminum.

Citigroup estimates China’s unlicensed aluminum production capacity to be in the region of 4 million tons a year — more than 10% of China’s total 2016 output.

The price rises have undoubtedly been exacerbated by speculator activity, as hot money has flowed into aluminum and zinc. The aluminium price is up 27% in Shanghai and 23% on the LME, with the zinc price rise not far off at 24% in Shanghai, driven by the same fundamental concerns over shrinking supply. Some skepticism remains about how vigorously Beijing will pursue its policy of closing “polluting industries” in the northern provinces during the winter heating period. But following the miscalculation of how robustly environmental enforcement would be pursued this summer, the market is rapidly reassessing the prospects of significant closures during the November-March period.

In reality, China is not short of primary aluminum, stocks are considerable and although demand is rising, supply is adequate. The narrative of supply shortages is a strong one that speculators seem intent to run with for as long as they can.

Under the circumstances, Citi may well be right that the current firm trend has some way to run and we can expect higher prices in Q4 and H1 of next year.

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The Trump administration is right to worry about the loss of American jobs and to explore the reasons for trade imbalances.

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But they are wrong for taking a blanket pop at free trade agreements and saying just because there is a trade imbalance that it is the fault of the agreement.

An article in Bloomberg reporting on recent discussions between U.S. Trade Representative Robert Lighthizer and South Korean Trade Minister Kim Hyun-chong this week illustrates the problem.

Lighthizer vaguely stated the U.S. administration is seeking “substantial improvements” that address the trade imbalance, adding that the U.S. wants to see the free trade agreement (FTA) deal “fully implemented.”

The Korean side and most independent observers are perplexed at what the U.S. actually expects to achieve.

Emissions Standards Too Strict, U.S. Argues

Bilateral trade has surged since KORUS, as the Korean-U.S. trade deal is known, was implemented five years ago. Although there is a trade imbalance, the reality is no two countries will have exactly balanced trade. Balances have more to do with relative competitiveness than a rigged system.

Bloomberg reports that South Korea is the U.S.’s seventh-largest trading partner, while the U.S. is South Korea’s second-biggest partner, after China. U.S. figures indicate its goods deficit with South Korea was $27.7 billion last year, or about $4.4 billion more than the number Korea came up with. The U.S. has cited non-tariff barriers in South Korea’s auto market as an example of the unfairness of the FTA, saying that South Korean emissions standards are too strict.

Honestly, can the U.S. (or anyone else) criticize another country for being too strict on emissions?

Japanese and European manufacturers meet the standards. Perversely enough, U.S. manufacturers comfortably meet the Korean standards — supporters say the FTA has helped U.S. automakers to surpass Japan to rank second in imported autos since 2015.

So, how are emission standards a barrier?

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An interesting article in the Financial Times explores the decline of global capital flows since the financial crisis and how the nature of capital flows has changed markedly since 2007.

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The article draws on research by the McKinsey Global Institute looking at how bank lending, particularly European cross-border bank lending, has shriveled up and been partially replaced by company fixed-asset investment. That, we would normally say, is a good thing. Foreign Direct Investment (FDI) is usually a more productive commitment by companies in factories and other facilities.

But the concern is the main factor behind the expansion in FDI has been the flow of investment booked in “financial centers” — the polite phrase for low-tax countries such as Ireland, the Financial Times says.

A lot of this money represents tax-motivated profit shifting that simply shows up on balance of payments as FDI flows.

Cross-border capital flows are down significantly from where they were when the global financial crisis began, the Financial Times reports. The $4.3 trillion that flowed around the world last year was only a third of the peak of $12.4 trillion in 2007. While no one is suggesting a return to those levels would be a good idea – much of that liquidity resulting from savings in China and other emerging market economies and the wealth of oil exporters found its home in U.S. property, helping build a bubble that led to the financial crisis — but nor is it healthy that firms are squirreling away billions off-shore to avoid tax at home. Think Apple’s massive off-shore war chest, as an example.

Another major change that the world is only just catching up to is the shift in capital account balances.

At the time of the financial crisis, China had the world’s biggest surplus while the U.S. had the largest surplus on its current account – mainly trade. Now, it is China and Japan, as the graph below shows, and politicians in the U.S. are only just catching up to the idea that Germany is the mercantilist of the second half of this decade, not China. It should be said, however, that all imbalances have declined relative to GDP.

Source Financial Times

Finally — and this will not come as any surprise — the role of mature economies is waning compared to emerging markets.

Developed economies are sending significantly less money overseas in the form of FDI than they did before the crisis. Their share of global FDI has also been falling as China’s role has grown. This is already causing a reaction in the U.S. and Europe to Chinese firms buying up famous and occasionally strategic firms and assets, and may yet lead to legal barriers being raised to prevent further encroachment.

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