Blinded By The Lust

–There they were, all around a heavy wood table in the office of the New York Federal Reserve. Paulson, Geithner, Dimon, Blankfein, Thain and more. Only Dick Fuld was missing. And that’s because they were picking over his investment bank, Lehman Brothers, like a carcass. “The West is *&^#$%,” says Paulson.

–That was last night, when we were watching the BBC produced drama, “The Last Days of Lehman Brothers.” Obviously no one at Rio Tinto, Fortescue Metals Group, or BHP Billiton was watching. Today’s Australian Financial Review reports that Australia’s three biggest iron ore producers plan to expand production in the Pilbara from 390 million tonnes last year to over one billion tonnes a year by the end of the decade.

–The capital investment required to meet those production figures is not going to be small. And more importantly, it’s based on a big idea: that the underlying demand for iron ore from China and the developing world may have peaks and valleys…but they’re all headed in a long march higher and higher.

–This is typical of the kind of hyperbole that you hear at the top of a commodity cycle. Producers announce big expansion plans, based on a demand that’s growing as far as the eye can see. The trouble is, the eye can only see so far. Especially when it’s got dollar signs in it.

–If China’s huge resource demand is itself derivative of the global credit boom of the last thirty years-which is our position as you might guess-that the record high terms of trade Australia’s enjoying are not a new normal but the same old high you get before the downside of the cycling. There’s nothing new under the sun, really.

–But even if the long boom in China will last for many years (as the head of BNP Paribas’ structured finance chief Dominique Remy believes) there is the little matter of China cooling its out of control consumer price inflation. The Wall Street Journal’s Aaron Black reports that China’s communist leaders are shifting to a more “prudent” monetary policy in 2011.

–Black says, that “Analysts generally expect China to impose a lower target for total lending by banks next year, and have said there could be additional interest-rate or reserve-ratio hikes by the end of this year. The central government has also shown great concern over the social impact of higher prices, rolling out a series of measures intended to help lower the cost of daily necessities such as food.”

–Too late for that, gentleman. As we reported in the Friday weekly update to readers of the Australian Wealth Gameplan, lending in China has grown nearly as much in 2010 as it did in 2009, despite a much lower official target by authorities. That money torrent is driving up real estate prices and speculation.


Source: The Wall Street Journal

–And while China tries to control the money pumps before the economy floats away on higher prices, the big takeaway from last week is that the Fed has now become the banker of last resort to the world. With the Belgians calling this weekend for an increased bailout fund in Europe, how long will it be before the ECB opens up new swap lines with the Fed to meet the European banking sectors mad demand for dollars?

–Maybe this is why gold is beginning to get jealous of the recent strength in silver. Neither metal is paper, and both are money. Hence their strength. Gold moved back over $1,400.00 on Friday and was up $16.90 on the day. But have a look at the chart below to see what’s coming.


–The chart is the gold/silver ratio, or the number of ounces of silver it would take you to buy an ounce of gold. When the line goes down, silver’s getting stronger relative gold. When the line goes up, gold is moving up faster than silver. So what does the chart tell you?

–It tells you that silver’s recent strong move nearly retests its strongest position relative to gold in the last ten years. The historical ratio of gold/silver-based on the ration of gold to silver in the Earth’s crust-is 15:1. Were that ratio to return, silver would trade around US$93.

–Based on the chart below, we’d expect silver to take a breather. But that doesn’t mean silver has to fall. It means gold may simply resume rising as two of the world’s reserve currencies (the euro and the dollar) are knifed in the back by their masters.

–Finally, Paulson’s fictionalised speech last night in the BBC was supposed to capture the moment when Wall Street’s elite recognise how much they’ve screwed things up. But there’s no real financial catharsis. Lehman fails and everyone goes back to life before Lehman, with socialised losses, bailouts, and more leverage. Until the next crisis…

Dan Denning
Dan Denning examines the geopolitical and economic events that can affect your investments domestically. He raises the questions you need to answer, in order to survive financially in these turbulent times.

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I can see the FMG line from my office. No trains at the moment but they keep coming. I first came up here in October 2008 as a fresh graduate to work on an FMG expansion project that was just starting up. 2 weeks later the project was canned. Now I’m back up here, to start work on that exact same expansion. I know a lot more now than I did then, and I will not be suprised to see history repeat. It certainly feels like I’m the only one up here who doesn’t expect this fairytale to go on… Read more »
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