The internet connectivity here at the lodge we’re staying in New Zealand is a little spotty. So we’re going to keep today’s notes short and get them out while we can…before the sheep storm our quarters. Honestly, outside either window we see hundreds of sheep…although on one side the mountains are in the background and on the other side, the Pacific Ocean.
But even the quality view has not improved our chances of getting to the bottom of plunging U.S. bond yields. Is it the carry trade? Are traders selling emerging market stocks and high-yield currencies and parking the profits in short-term U.S. notes? There are no corresponding down moves in other asset classes that we can detect. It remains a riddle.
In the meantime, the capital crisis in banks we wrote about yesterday has moved from the West to the East. The Financial Times reported overnight that the surge in Chinese bank lending in 2009 led to a fall in core bank capital. Now the banks need to buffer up. That sounds familiar.
And while we’re on the subject of China we should relay that Citic Pacific Ltd, which is an arm of China’s largest state-owned company, is set to spend more on magnetite iron ore projects in Australia. Magnetite is a lower grade ore than the hematite ores that BHP and Rio have all but locked up in the Pilbara.
Citic is seeking to guarantee supply and diversify its suppliers. It’s not alone in chasing the lower-grade magnetite projects either. ABARE says up to $18 billion will be spent on magnetite projects, a 36% increase over last year. So why the rush to dominate the lower-grade ore market?
“Hematite is first choice, but the Chinese objective is probably a little different,” Sydney analyst Grant Craighead tells Bloomberg. “They’ve got more the 100-year view that ‘we need to be putting our foot down on resources.” It could also be the case that China’s trying to build an iron ore supply network that doesn’t rely so much on BHP or Rio Tinto.
Hmm. 100-year view? It could be. But the ten-year view could be that China has way too much steel-making capacity already and that securing more ore now for an industry that’s already oversupplied doesn’t show much foresight. But hey…when you have two trillion in U.S. dollar currency reserves…you have to do something with them. Digging a hole in the ground to find iron ore will do.
And speaking of digging holes in the ground, gold miners say gold production will fall in the coming years, despite a rebound in 2009. The miners are singing the same tune: existing deposits are played out and we aren’t finding any new big ones.
“2009 is the outlier as far as the trend,”Omar Jabara, spokesman for US-based Newmont Mining, tells the AFP. “It’s a fact that gold production from mines has been in decline since 2001 and has gone roughly from 85 million ounces to about 75 million ounces a year,” says Vincent Borg, a spokesman for Barrick Gold.
Everyone talks his own book. And with gold futures up $23 in the futures market, the gold price is hovering just below US$1,200. You’d expect the gold producers to be beating their chests and pounding the table right about now.
Whatever is going on, gold seems to be giving some comfort to investors who are having a hard time figuring out what to expect from financial markets. This fits David Einhorn’s theory that gold does well when monetary policy is poor and poor when monetary policy is good. Monetary policy is not so good now.
Finally, our host here in New Zealand thinks he knows what might be behind the low short-term U.S. yields: an accounting change. On January 1st, 2010, Federal Accounting Standards revision 167 comes into effect. It requires banks to bring off-balance sheet assets back on to books.
If the assets were bad, or even if they were just large, the banks would have to set aside more capital to satisfy capital adequacy ratios. One way of doing that in advance, we speculated yesterday, is loading up on short-term U.S. debt. It would bolster the asset side of the balance sheet.
It’s not so clear that loading up on short-term U.S. debt actually improves a bank’s capital position, though. At least it’s not clear to us. So we’ll investigate it and get back to you. Until then, a happy Thanksgiving to all you U.S. citizens celebrating abroad today. Just remember, wherever you are, the idea of America is too.
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