China debt crisis

Fears of a looming China debt crisis 

Equities around the world got dinged and the yen jumped Wednesday after Chinese money-market rates spiked and a Bloomberg story said China’s biggest banks had tripled debt write-offs. So, what is going on?

Given concerns earlier this year about the Chinese shadow banking sector it would appear that the acknowledgement that there is a problem and Chinese authorities are starting to deal with it has seen some investors take some money off the table in case there are a lot more provisions to come,

It’s no wonder officials and investors are keeping a close eye on the situation. A major hit to the Chinese banking sector is likely to have massive ramifications across the G-20 universe and could have a deflationary impact on global growth. Little wonder then that Aussie saw so much selling pressure in overnight trade as it will likely suffer the most from any drop off in Chinese demand.

After falling sharply in recent days, especially yesterday after the disappointing jobs data, the US dollar is broadly higher today, with the yen the main exception.  It has strengthened by almost 1% today.  

Many are attributing the price action to news that the five largest Chinese banks tripled the bad loans written off in the first half of the year to CNY22.1 bln (~$3.65 bln). Yet, tellingly and importantly, the Chinese banks had already made the provisions and thus did not, reportedly, impact the record profits (~$76 bln) in H1.  

There is some speculation that this is a precursor to a wave of defaults, but in itself writing off the bad loans is a very important step in its own right.  It is a step toward modernization and liberalization.  Provisioning for bad loans and then drawing on those provisions is part and parcel of a modern banking system.    

Precisely why one would sell, say the New Zealand dollar, the weakest major currency today, losing about 1.4% through the European morning, or the Mexican peso, which, with a 0.8% loss is the weakest among the emerging market currencies, in response to Chinese banks writing off bad loans in the first half of the year, is not immediately self-evident.   Indeed, not writing off bad loans, we would argue, was part of the problem.  Writing off bad loans is part of the solution.  For the record, the yuan itself rose to a new 20-year high against the dollar.  

There is another liquidity squeeze in China today.   Corporate tax payments are draining liquidity and thus far the PBOC has not deemed it necessary to counter this.  However, after money market rates jumped the most since July, the PBOC is likely to respond tomorrow.  The 7-day repo jumped 47 bp to 4.05% and the 1-day repo rose 72 bp to 3.80%.  

The PBOC's ability to manage the liquidity conditions seems clumsy and often responding belatedly to clear signals of important imbalances.  Admittedly, at times, the PBOC may be trying to send a signals of displeasure, like it did earlier this year, about wealth management products and shadow banking.  That does not seem to be the intent now.  

The firmer headline CPI, though still concentrated on food prices and not the general price level, and rising house prices has spooked some investors who feared a policy response.   The rise in money markets is not a prelude to a rate hike or a snugging of monetary policy.   That is in fact, the point, there is no policy implication, except to reinforce the perception of the PBOC's difficulty in managing liquidity.  

The rise in money market rates may be a key spur to the largest decline of small company share prices in a year and a half.  The ChiNext index of small companies fell 2.9% today, more than twice the decline of Shanghai Composite.  In comparison, Japan's JASDAQ fell 0.8%, while the Nikkei lost almost 2%.  

It strikes us that many observers seized upon the story to explain the price action throughout the capital markets.  We suspect that if the markets were advancing, many would cite Chinese developments too.  Instead, we suggest there have been some large moves in recent days, and the new positions were in weak hands.  That is to say, the dollar and yen's bounce and the pullback in shares is more a function of market positioning than Chinese banks finally writing down bad loans four months ago, for which provisions were already made. 

Next Stop : Vladivostok

Russia's Railway Expansion and Asia-Europe Trade

Moscow hopes to increase overland transport of goods between the two continents.

As Stafor reported none other than Russia is betting big on the key rail link connecting continental Europe with the Pacific: the Transiberian Ralway. The reason: rail-based transport between Asia and Europe is considerably cheaper than seaborne transit, and Russia's infrastructure investments could relieve economic pressure on European and Asian countries that are struggling to maintain current trade levels. 

The Trans-Siberian Railway is capable of moving some 120 million tons of cargo each year, and around 13 percent of container trade between Europe and Asia utilizes the line. And if Putin has his way, which he will, there is much more to come - a recently approved $17 billion expansion of the 9,300-kilometer (roughly 5,800-mile) railway would add another 55 million tons of capacity by 2018 -- a 46 percent increase.

The railway expansion will be accompanied by several other infrastructure projects. According to Russian railway and port operator N-Trans, Russia will triple rail-to-port capacity in its Pacific coast terminals by 2020. In addition, the port at St. Petersburg is expanding by 44 percent, and German engineering giant Siemens signed a $3.2 billion deal in 2012 to supply 675 cargo electric locomotives to Russia.

In addition as we extensively covered previously - see The Silk Road - there is the alternate track from China through Kazakhstan (now part of the custom union) and a bridge to Western Europe Through Belarus and Poland.

 

Moscow has two goals in the railway expansion.

First, it hopes to boost its exports of raw commodities. Russia has become among the top oil producers and exporters in the world, and around 250,000 barrels of Russian oil is transported to Asia by rail each day -- an amount that could increase with the Trans-Siberian expansion. The coal industry too would rely on an expanded Trans-Siberian Railway for exports to Asia.

Second, and more important, the upgraded railway would also give Russia a more prominent role in trade between Europe and Asia.Currently, goods from Asia can reach Europe in roughly 10 days via the Trans-Siberian Railway. By comparison, seaborne goods from South Korea or Japan, for example, take around 28 days to reach Germany and 40 days to arrive in St. Petersburg. Moscow hopes the rail expansion will make overland transit through Russia even more attractive as an alternative to seaborne routes.

Emerging Chronicles

Why You Should Worry About Inflation 

in the Developing Economies

China’s consumer price index rose more than expected in April, while wholesale prices suffered a steeper fall. The April CPI showed a gain of 2.4% from a year earlier, led by a 4% rise in food prices, the National Bureau of Statistics said Thursday.The producer price index, meanwhile, fell by the most since October, dropping 2.6% against a decline of 1.9% in March.

Investors in local currency emerging market bonds should recognize the threat of inflation and consider protecting themselves against it.

While it is difficult to believe that inflation will be much of a problem in the Advanced Economies (AEs) over the next several years, there are reasons to worry about inflation in the Developing Economies (DEs). This should be of particular concern to those contemplating investments in emerging market local currency bonds.

The threat reflects a number of factors:

• Inflation is already high in the DEs. According to the IMF, consumer prices (CPI) rose 5.9% last year.1 Moreover, they have risen at an average 6.4% annually over the last ten years,1 suggesting that inflationary expectations are entrenched and inflation therefore more difficult to bring down.

• The DEs are growing robustly, and have been throughout the global recovery, reducing levels of surplus capacity and increasing the potential for a further acceleration of inflation.

• Price indexes in the DEs are typically comprised differently from those in the AEs, with both food and energy obtaining much larger weights. This makes it difficult for policy makers to control inflation because both are determined by global as well as domestic conditions.

• To the extent that governments and central banks in the DEs influence core inflation, they are currently inclined to run too accommodative a monetary policy to prevent exchange rate appreciation, thereby increasing upside risks.

While there are obviously individual countries in the developing world that boast low to moderate inflation, consumer prices generally rose quite quickly in the DEs last year. Prices rose 4.5% in Developing Asia, 5.8% in Central and Eastern Europe, 6.0% in Latin America and 10.7% in the Middle East and North Africa.1 Moreover, the numbers were not overly distorted by extreme outliers (one country experiencing hyper-inflation and thus distorting the average) as the median inflation rate in the DEs was 4.9%.

The relatively poor inflation performance in the DEs is not new. Indeed, over the last 10 years, consumer prices have risen at an average annual rate of 6.4%. Such a protracted period of relatively high inflation affects inflationary expectations, effectively embedding them into the wage bargaining and producer pricing processes. Until these expectations unwind, policy makers will find it difficult to lower inflation.

The DEs have grown relatively robustly during the global recovery. Using the IMF’s purchasing power parity aggregates, real GDP has grown at an average annual rate of 6.3% over the last three years, and while it slipped to 5.1% last year, it is projected to reaccelerate by about 0.2 percentage point to 5.3% this year.1 The speed and persistence of growth suggests that output gaps have already narrowed and will narrow further this year, posing an upside risk to inflation.

The CPI is often disaggregated into food, energy and core. In AEs, food and energy typically obtain weights of around 15.0% and 7.0%, respectively, leaving the core index at around 78.0%. However, in DEs, food can obtain a weight of 50.0%, and energy of 20.0%, leaving core at just 30.0%. Given that the price of food, and particularly energy, are heavily influenced by global as well as domestic economic and other conditions, policy makers in DEs have a much more difficult task controlling inflation. Moreover, given the capacity for large and sudden swings in food and energy prices, headline inflation is inherently volatile in the DEs.

Although some countries such as China, are attempting to become more balanced, DEs typically depend on exports to drive growth. Hence they fret about international competiveness. Given the extremely accommodative monetary stance of the AEs, the DEs are currently apt to keep monetary policy easier than domestic economic conditions would otherwise dictate in order to prevent exchange rate appreciation and the associated loss of export competitiveness. (That partly explains why the recent policy moves by Japan were met with such hostility.) India seems to provide a good example of this phenomenon, as the Reserve Bank cut its key policy rate 100 basis points over the last year despite a CPI inflation rate of 10.4%.

In summary, investors in local currency emerging market bonds should recognize the threat of inflation and consider protecting themselves against it.

"Real" Inflation in the US

P.S. To have a broad picture citing The Economist's Big Mac index, Peter Schiff says real inflation has been understated since the government started adjusting the way inflation was measured in the early 2000s. Since 2002 the Big Mac has risen in price at nearly three times the rate of overall inflation.

Emerging Markets Roundup

Following the Smart Money

(See our previous  global research : Searching for New Emerging Markets )

Forget indexing. In the emerging markets, a more complicated global economy calls for a more sophisticated strategy. Here it is. The opportunities of investments remain high. It is however necessary to refine from now on our strategy of investment according to the particular case of every country. It is our quest  in our search for new merging countries  to inform you of the best opportunities throughout our tours in Emerging Markets.

Hence we shall determine and offer our best recommendations in terms of opportunities of investment. The  supposed "fall" or "increasing power" of BRICS means anything in particular. Since then it is necessary for us to analyse independently one from another.

For nearly a decade, the key to successful investing in emerging markets could be summed up in a single word: emerging. Economies like Brazil, Russia, India, and China were creating an emerging middle class, which in turn would create emerging demand for consumer goods, commodities and everything in between. It was a virtuous cycle -- or so it seemed. In the five-year period from 2003 through 2007, the MSCI Emerging Markets Index compounded at a 36% annual clip, and all it took to make money was to buy the index or a fund that hewed pretty closely to it.

Then came the global financial crisis, complete with a near-worldwide recession, housing and stock market crashes, and endless political strife -- all rooted in the developed markets but nonetheless affecting the emerging markets. The so-called BRIC countries, which make up 43% of the index, initially made a strong comeback in 2009, but have faltered since, dragging down the whole group. The broad indexes that track emerging markets are skewed toward the largest companies, which are often state-run and sometimes managed for political gain rather than economic gain. They're also typically export-oriented, dependent more on Americans buying gadgets or on commodity prices than local demand.

While the MSCI Emerging Markets Index is down 2% over the past year, other markets have fared far better. It is the first time in 15 years that developing shares have underperformed during a global market rally. They are, it seems, victims of their own decade-plus of outsize success, with their governments trying to contain inflation while keeping growth at a satisfactory pace. 

Though the BRICS (Brazil, Russia, India, China, Southern Africa) did not say their last word. They held last week their fifth summit in Durban. See Summary. 

They have faced serious growing pains. Brazil's economy grew a scant 0.9% last year. India is projected to grow at just 5% this year, the slowest rate in a decade, and while China averted a much-feared "hard landing," its new leaders are targeting economic growth of 7.5%, down from its 10% rate of recent years. Uncertainty about how the leadership of both nations will handle the current economic conditions is keeping pressure on their broad stock markets -- and hiding some gems.

see Buy India - Sell China


For first three months of the year, the developed countries markets  progessed of 6,6 %, against 3 % for the emerging countries.

S&P500 - green - and MSCI EM (orange)

Of course, competition to catch up with the qualification level of the developed countries remains long and perilous, or at the end only a few will know the destiny of Taiwan or of Chile. However our disappointment today is just like our past enthusiasm : excessive. 

There are exceptions to this trend, like Thailand and the Philippines. The latter, in fact, was highlighted by Turner Investments touting the era of the TIMPs, which groups Turkey, Indonesia, and Mexico alongside the Southeast Asian upstart. See  paper (PDF)

The MSCI Frontier Markets Index, which includes Pakistan, Kenya, and Vietnam, is up 9%. The JPMorgan Emerging Markets Bond Index Global Diversified index of dollar-denominated sovereign debt in these markets is up 17%.

Carve up the emerging markets even finer, focusing on where local consumer markets are thriving, and the results are even better: The MSCI Philippines index, for example, is up 39% in the past year; Nigeria is up 70%; and Mexico is up 17%.

See Mexico's Trust Buster

Hence we shall determine and offer our best recommendations in terms of opportunities of investment. The  supposed "fall" or "increasing power" of BRICS means anything in particular. Since then it is necessary for us to analyse independently from one of another.


The opportunities of investments remain high. It is however necessary to refine from now on our strategy of investment according to the particular case of every country.
It is our quest  in our search for new merging countries  to inform you of the best opportunities throughout our tours in Emerging Market 

There are two ways to invest and profit from this developing trend :

• Agricultural commodities

The total increase in commodities prices in 2000s did not distinct between producing countries, either they are producers of guavas, of soya or of copper. Today, evolution of prices is  more contrasted according to the type of commodity to the. Also, some countries succeeded in rationalising their production to remain profitable, others still wait from new price explosion to balance their budget. The first have a good future.

• The new emerging countries (our triple D's)

The slower growth in China can also be viewed as the result of its rise in power. By externalizing the productions which made its glory over these 20 last years, China offers the opportunity to new countries to register high growth.

The set back move which we identified in the emerging countries tis last year is explained by an only big reason, the Chinese slowdown. Indeed, put out India, which economic model is based on services, the other three partners of China are first suppliers of raw materials. That it is Russia (oil, gas), Brazil (soya and iron) or South Africa (platinum). That is why the above mentioned common plans have an interest only as much as China, main provider of fund of these plans, will be capable of financing them.

Understanding the emerging countries and identifying the emergence of new countries, means first to understand where does Beijing go. 

Let’s review the Chinese  situation today and then we shall recommend then three new horizon of investment

Facilities

Investments dedicated to the production plants went down from 30 % to 20 % over the 10 past years.

The profitability

According to the analysis, the profitability of the capital was reduced.

The abundance of the work force

The rural exodus which pushed millions of not qualified workers to migrate to the factory plants is decelerating, causing in some places a shortage of work force and an increase in wages.

Urbanization

The urbanization of the Chinese population continues, but at a lesser pace than these last years. It is this phenomenon which supported investments in facilities, in buildings or else in transports.

It is not possible to say that this slowdown is a surprise. The stages of development of any country are characterised by specific criteria. So, according to study, the level of the GDP per capita in China corresponds to the entrance in an intermediate stage, or the per capita income is "medium", around 6 000 $ a year. Consequently, the analysis assumes a Chinese growth from 10 % to 6,5 % before 2018.

The reasons of optimism remain present, however. Simply because the level of current development of China is comparable to that of Japan in 1970s, and of South Korea in 1990s. What means on one hand that there remain theoretically some years of strong growth for China, and on the other hand that in longer-term, China is going to continue its growing trend to get closer to the level of the developed countries.  Chinese GDP per capita is still only the fifth of that of the United States.

How to use this growth ? 
A new model of development is being put into place. The increasing power of consumption, awaited for a long time, should finally arrive. The part of consumption in the GDP should pass from 48 % currently to 56 % before 2022.

As you understand it, change will be slow  and requires time to be put into place. However, opportunities to invest on other economies in full boom, which they enter their 30 glorious barely, are existing 

The Consumer

Undoubtedly, the most tempting part of the emerging markets story is the consumer. Since 2008, consumer-oriented sectors, such as health care, staples (such as food and household items) and consumer discretionary (retailers and media companies) have outperformed. Markets such as Thailand, Colombia, and Turkey, which are skewed toward consumption, have racked up double-digit gains in the past three years. Funds that hew close to the broad index, however, likely missed the bulk of those gains, since the three sectors make up just 18% of the index and those three countries comprise only 6% of the index's assets.

There are several ways to gain access to the sought-after emerging-markets consumer, including U.S. or European companies like Nike (NKE), which gets a quarter of its sales from emerging markets, and LVMH Moet Hennessy Louis Vuitton (MC.France), which gets about a third of its sales from emerging markets.

Small and Frontier Markets

While much of the developed world has been starved for economic growth, a handful of smaller markets -- including countries as far-flung as the Philippines, Indonesia, Mexico, and Turkey -- have expanded enviably, largely on the heels of economic reform and newfound political stability. That's led to gains as high as 39% for the Philippines in the past year, and 17% for Mexico, and strong inflows into both markets. Both markets now seem a bit pricey at first glance: The Philippines trades at 17 times and Mexico 14 times next year's earnings, compared with the multiple of nine for emerging markets as a whole.

Southeast Asia, the other China 


It is almost like a historical trend. Japan developed from a model supported by a low cost work force and an exporting economy. Once reached some levels, South Korea and Taiwan took over the model. Then China. Currently, it is the turn of the South east Asia countries to copy the model.

So the Philippines today use a model mixing weak currency and low labour costs, to support the growth of the country at 6,4 % last year. Better, Standard and Poor' s raised the note of the country debt. And forecasts are exceptional also. According to the bank HSBC, the country should pass from the 44th place of economies of the world to the 16th in 2050.

See Myanmar's huge potential

Another country is making headlines : Malaysia. Malaysia is competing with China on its own ground. So, during the summit of Durban, an analysis of the Conference of the United Nations on trade and development (Unctad) showed from now on that Malaysia is the third investor in Africa, behind France and the United States, but in front of China.

This performance is explained as for Philippines by Malaysian capacity to keep a high growth rate in 2012, even though the exporting markets slowed. It is however necessary to underline that it is the oil which brought in Malaysia an important part of its growth (40 % budgets of the government). 

Of course, there are investments on the local companies of the country, which are better and better managed. For some investors who would have an expsoure in the Malaysian market, the oil group Petronas is being transformed into one oil major, and an can be interesting target is.

Increasingly, advisors are also adding a little exposure to frontier markets like Sri Lanka, Vietnam, and sub-Saharan Africa -The latest development for Africa see The Economist -

They're in an earlier phase of consumption and offer longer-term growth potential. Frontier markets -- typically defined by fast economic growth but nascent stock and bond markets -- also offer greater diversification. With a 0.61 correlation to the MSCI All Country World Index and a 0.60 correlation with emerging markets, frontier markets have offered some of the highest diversification in the world of stocks over the past decade.

Experienced managers, still say they can dig up some deals in what appear to be pricey markets. Investors sometimes balk at valuations too quickly, underestimating the longevity of some consumer trends,for instance Nestle Nigeria (NESTLE.Nigeria), which trades at 21 times 2014 earnings. That's not an unreasonable level, based on the country's per capita gross-domestic-product figure. 

Consumers now have more income, and are willing to pay a premium for branded food and beverages. A similar situation played out in India with Nestle India (Nest.India), she says. Nestle India now trades at 31 times forward earnings, but was far pricier in 2000.

Other small markets are attractive because the returns haven't been as outsize. Indonesia's 6% return in 2012, for instance, paled in comparison with its neighbors. Though blessed with resources and a large and young population, investors have been wary of Indonesia because of its high current-account deficit and weak currency. But some money managers say the softness in the Indonesian market allows them to scoop up companies with good long-term potential.

The New Way to Play Emerging Markets

Investing in the developing world has become a lot more complicated, and sophisticated investors are taking a much more nuanced approach. These funds capitalize on the big themes in emerging markets today.

Cheap Markets

Looking for the cheapest markets brings investors back to the BRICs, specifically, Brazil, Russia, and China. BRIC funds have seen outflows in 50 of the past 51 weeks, according to EPFR Global. While these countries struggle to navigate slower economic growth, they are bound to recover from their recent slumps. Earnings expectations are steady, whereas they are being cut in Europe and the U.S. Meanwhile, BRIC valuations have dropped to levels that are piquing managers' interest.

Few money managers, for instance, expect to see much change in the transparency and governance issues that have kept Russia on the cheaper end of the spectrum. And state-run companies in any country pose a risk. But with the market trading at just five times earnings and energy giant Gazprom (GAZP.Russia) trading at three times, it's cheap enough to warrant a look, even though it's 50% government-owned.

There are also catalysts to watch for. Brazilian stocks will get a reprieve if the government backs away from recent interventionist measures, such as trying to keep a lid on energy prices and pushing banks to lend. Just one example: Shares of the state-run Brazilian energy giant Petrobras (PBR) rallied 15% earlier this month after the company raised diesel prices -- a move it was able to make as government pressure to keep energy prices low eased. Some managers are looking at banks and real-estate investment trusts in Brazil as indirect consumer plays that are cheaper than retailers and other more obvious consumer stocks.

China, as mentioned before, is a more complicated story. Wages are rising, which means consumer stocks are appealing, as are some more subtle plays, like automation companies that can replace pricey workers. The most obvious consumer plays, even in these battered markets, are not bargains, but there are plenty of indirect ways to tap the consumer that are still reasonable, like Chinese PC maker Lenovo Group (992.Hong Kong) as a way to tap demand for computers and smartphones in emerging Asia, especially smaller markets other global players may not be able to easily tap. Lenovo derives two-thirds of its sales from emerging markets. Reynal is also looking at natural-gas companies as China struggles to combat its record levels of smog.

As the Chinese focus on cultivating domestic demand, smaller local players will be among the beneficiaries. The trouble for U.S. investors is that the universe of companies to invest in is far more limited for those investing in China through the more-accessible Hong Kong market. The Chinese A-share market -- mainland China's two stock markets, Shenzhen and Shanghai -- is denominated in the local currency and restricts foreign investment. But many of those stocks are more geared toward the "new China" story, with companies targeting the smaller cities that are in the earlier part of the consumption cycle. But the greater volatility and restrictions make it difficult for even professionals to invest. Just a handful of U.S. managers invest in A-Shares, including the tiny $43 million Aberdeen China Opportunities (GOPAX), which has the highest exposure at 5% of assets, according to Morningstar.

Dividend Payers

If dipping into these riskier areas makes you queasy, dividend stocks can offer some relief. Over the past decade, dividend-paying emerging-market funds have generated better returns and less volatility than the MSCI Emerging Markets Index, according to Morningstar. The average dividend yield of 2.7% in emerging markets and 3.9% in frontier markets is undoubtedly attractive as well.

But there's another reason to own dividend payers. As investors move into smaller markets where information is harder to find, dividends may be one of the best road maps available, since they telegraph a management's confidence in the future, ie : Forward Select EM Dividend Fund (FSLRX).

Here, too, there are some ETF options, but look carefully at their holdings before investing. The $114 million iShares Emerging Markets Dividend ETF (DVYE) yields 3.5%, though 29% of its portfolio is in developed markets. The WisdomTree Emerging Market Income Fund (DEM) yields 3.4%, but one thing to note: After its latest rebalancing, it's more heavily skewed toward Chinese financials -- an area some managers are wary about given the country's shadow banking and nonperforming loans.

Bonds

Yield-seekers have recently discovered emerging-market bonds, and have poured in $144 billion since the beginning of 2010, according to EPFR Global. The appeal is clear: Dollar-denominated government bonds from Russia, Brazil, and Turkey yield more than a full percentage point than Treasuries and are arguably in stronger fiscal health.

But yield isn't the only reason to include bonds in your emerging-markets portfolio. Emerging-market debt offers greater geographic diversification, even when sticking to the index: The JPMorgan Emerging Markets Bond Index Global Diversified index has almost 70% in Latin America and Eastern Europe, for instance, while its equity counterpart, the MSCI Emerging Markets Index generally has about 25% there. What's more, bonds can provide access to economies in the earliest stage of development -- like Senegal or Angola -- through their government bonds, often before there is a sufficiently liquid and vibrant stock market.

Bonds denominated in dollars have garnered the most attention and vast sums of new money. That doesn't bode well for the short term, but in the long run there's still room for big gains. Emerging-market debt makes up just 5% of fixed-income investors' assets, but these economies are on track to account for half of global economic activity, says Jan Dehn, co-head of research at Ashmore Investment Management, which oversees $71 billion in emerging-market assets.

In the shorter term, managers see more upside in sovereign bonds denominated in the local currencies and dollar-denominated corporate bonds -- many of which have yields into the low teens.

Investing in local-currency debt also helps investors diversify away from the dollar. Many noted investors, including Pimco's Bill Gross, have warned that the United States' burgeoning debt levels can cause inflation and a weaker dollar.

Developing countries have more robust reserves and a fraction of the debt -- China, for instance, has $3.6 trillion in reserves -- setting the stage for stronger currencies in the long term. 

Corporate bonds are also attractive, with improvements in credit quality and a greater variety of companies looking for financing. Bond investors can tap industries like railways in Georgia and telecoms in Panama that don't have many liquid publicly traded stocks. Bonds can also be more resilient than stocks, especially in times of government intervention. When the Chinese government announced stricter lending standards earlier this month, Chinese property stocks tumbled 8% in the week following the announcement, but the bonds fell only 0.2%.


Follow us on our site Investlogic

A Reason to Trust Central Banks?

Central bank diversification strategies 

– rebalancing from the dollar and the euro -

It’s clear that central banks around the world are buying gold in record quantities. It almost makes you wonder... do they know something we don’t?

A new report by the World Gold Council, “Central bank diversification strategies – rebalancing from the dollar and the euro”, examines the growing trend of central banks’ actively looking to diversify their reserve portfolios. While the dollar is still the primary global currency, its long-term dominance is less certain. In response, central banks are reducing allocations to US dollars and euros while increasing purchases of traditional assets such as gold and Japanese yen and new alternatives including Chinese renminbi.

Download the full report using this  direct link

The following table lists the countries that have added to their gold reserves this year, while the second one tallies those that have been selling. You’ll see how recently each country has reported, along with its percentage increase.

Russia isn’t alone, of course. Central banks as a group have been net buyers for at least two years now. But the 2012 data trickling out shows that the amount of tonnage being added is breaking records.

Based on current data, the net increase in central bank gold buying for 2012 was 14.8 million troy ounces — and that’s before the final 2012 figures are in for all countries.

This is a dramatic increase, one bigger than most investors probably realize. To put it in perspective, on a net basis, central banks added more to their reserves last year than since 1964. The net increase — so far — is 17% greater than what was added in 2011, which was itself a year of record buying.

Whatever gold’s price movements, positive or negative, central bank officials have continued adding a lot of ounces to their reserves.

See also previous post on Gold reserves

Here’s a picture of total central bank reserves since the financial crisis hit.

Jim Rickards, a highly respected author and hedge fund manager, said last month that China has probably already accumulated between 2,000 and 3,000 tonnes of additional gold reserves. If he’s right, that would be roughly double or triple the 1,054 tonnes it reported in 2009Well, Jim thinks the next big catalyst for gold will be an announcement from China about its reserve position. Here’s what he told in late December :

“The catalyst for a spike into the $2,500 to $3,000 price range for gold will be an announcement by China, probably in late 2013 or 2014, that they have acquired 4,000 tonnes or more in their official reserve position. This will put China on an equal footing with the US in terms of a gold-to-GDP ratio, and validate gold as the real foundation of the international monetary system.” 

Others provided clues as well.

Evgeny Fedorov, a lawmaker for Putin’s United Russia Party, said last week, “The more gold a country has, the more sovereignty it will have if there’s a cataclysm with the dollar, the euro, the pound, or any other reserve currency.”

President Vladimir Putin told his central bank not to “shy away” from the metal, adding “After all, they’re called gold and currency reserves for a reason.”
The Chinese have been quiet on this topic recently, after being very vocal a few years ago. Here’s a recent quote.

“The current international currency system is the product of the past,” said Hu Jintao, former General Secretary of the Communist Party of China.

“We’re in the midst of an international currency war,” said Guido Mantega, finance minister of Brazil.

“Quantitative easing also works through exchange rates... The Fed could engage in much more aggressive quantitative easing, to further lower the dollar,” said Christina Romer, former chair of the Council of Economic Advisors.

“We’re just going to kill the dollar.”
Economist Kyle Bass recently spoke to a senior member of the Obama administration about its planned solutions for fixing the US economy and trade deficit. When he asked, “How are we going to grow exports if we won’t allow nominal wage deflation?”, the answer he got was, “We’re just going to kill the dollar.”

Yes, we’re talking about the US dollar. Perhaps some investors have gotten complacent about the risks to the world’s reserve currency — but not central bankers. It’s not hard to see why: whether they admit it or not, central bankers must know what it means to run the printing presses the way the US has since 2008, even if price inflation is not immediately obvious. It’s no surprise they want to hedge their bets, moving more reserves into something with actual value... something that can’t be debased by a few computer keystrokes by an increasingly unfriendly government.

The US dollar has been the world’s reserve currency since WWII. That’s beginning to change, and the movement into gold is just one facet of that change. The buying by central banks is exactly what one would expect to see as we approach the end of the dollar hegemony.

The message from central banks is clear: they expect the dollar to move inexorably lower. It doesn’t matter that it’s been holding up against other currencies or that the economy might be getting better. They’re buying gold in record amounts because they see a significant shift coming with the status of the dollar, and they need to protect themselves against that risk.

This leads to a second message: gold is not overpriced, in spite of the 500%+ increase since 2001. Indeed, with the recent correction, central banks are likely buying more, even as you read this.

Central bank gold buying will continue, of that we’re certain. Even after Putin’s binge, gold accounts for only 9.5% of Russia’s total reserves. China’s 1,054 tonnes is roughly 2% of its reserves. It’s clear that both countries, along with others, have decided to accumulate as much gold as they can, as quickly as they can, before the dollar’s decline becomes more pronounced... and permanent. This could explain why some central banks don’t publicize their purchases. It also means that Bloomberg and other mainstream media outlets could be caught off guard when China announces higher gold reserves than expected — perhaps much higher.

Clearly we should take notice. If central banks are preparing for a major change in the value of the dollar, shouldn’t we? The fact remains that the US dollar cannot and will not survive the ongoing abuse heaped upon it by government planners and federal officials. That not only means the gold price will rise, but that many, if not most currencies, will lose a significant amount of purchasing power. This has direct implications for all of us.

Embrace the messages central bankers are telling us — the ones they tell with their actions, not their words. Buy gold. Your financial future may very well depend upon it.