Trade Deficit Still High by Historic Standards

On the surface, the week begins with a tale of two economies, each headed in seemingly opposite directions. In Australia, retail sales rose in November by 1.4% to over $20 billion, according to ABS data released last week. It was the strongest monthly rise in eight months. And that was before Christmas shopping really got under way.

Meanwhile the country’s trade deficit even narrowed. Both imports and exports were down, but imports were down more. The November trade deficit was $1.7 billion. That was $380 million less than the previous record of over $2 billion, and even lower than economists expected.

But hang on. How can you have falling imports AND rising retail sales? Food, textiles, consumer electronics…you’d think that falling imports would lead to falling retail sales. One possible explanation is that a big chunk of Aussie imports come from capital goods. These are the machines and equipment used by the mining industry to expand capacity and production. And imports of these have not yet risen to increase export capacity and production.

In that sense, maybe imports and retail sales are not as directly linked as you might think. But really it’s the general trend we’re after. And that trend is this: the trade deficit is still high by historic standards. And it may get even higher if exports fall.

Exports did fall, in fact, to about $19.3 billion in November according to ABS data. But all the hot money is now betting on another export surge, both in volume terms and value terms. And in fact, from early December of last year to now, metals prices have been an absolute tear in the futures markets.

Tin, nickel, zinc, lead and aluminium are all up by double digits over the last two months. Futures traders are going hog-wild pricing in continued Chinese demand and a global recovery in 2010. Copper made a 16-month high last week and was up 140% in 2009. All of that seems wildly bullish.

Or is it speculatively bullish? We’ll see. Friday’s discouraging payroll report in the US – 85,000 non-farm jobs disappeared in December – took the wind out of copper’s sails. So did the report from newswires that China’s central bank is hiking interest rates on short-term debt. This sent the signal, or the perception, that China’s monetary authorities are getting a bit worried about inflation.

Of course one way of looking at the rise in metals is precisely as an inflationary hedge. Non industrial metals demand would come from traders, speculators, and stockpilers either front-running the recovery story or simply looking for a place to park excess liquidity. That makes the metals rise price less straight forward and probably a lot more vulnerable to a correction-starting today.

Later today, we’re headed over to the editorial shop to speak with the research team on what they’re seeing, buying, and selling. We’ll put the question to them of the metals price rise and see what they say and advise. Stay tuned!

One question that we’ve been getting a lot lately is how to invest in these big ideas. How do you go short U.S. Treasury bonds, or long U.S. interest rates, or long precious metals like platinum and palladium without actually buying stocks or the metal (if that’s the kind of trade you’re after? The obvious place to look is the exchange traded funds market (ETFs).

ETFs are starting to catch on here in Australia. In the States, the ETF universe has grown massively since we first started using it to trade options on sector funds in 2003. But even if you’re not interested in owning or trading ETFs, or options on ETFs, you have to pay attention to the way they affect markets, especially for commodities.

To back up a second, an ETF basically securitises a commodity or asset class. It makes it possible for you to speculate on the rise or fall in price of a whole class of securities (like money-centre banks for example) or a specific commodity (like gold or oil). It’s a strange kind of security, and you don’t do security analysis for ETFs the way you do for single stocks.

In fact you could probably say ETFs are more for punters than investors. But they do allow you to make simple directional bets on asset prices. And more importantly, when new ETFs come online for certain commodities, it makes that commodity, as an investment idea, a lot more accessible to retail and institutional investors. The result is rising liquidity, which often leads to new demand for the underlying commodity.

A current example would be platinum and palladium. Several new ETFs which track platinum and palladium prices are due to hit the market soon. This ought to add a new element of investment demand to these markets and could boost prices. But should you buy the ETFs?

The trouble with the newer breed of ETFs is that the way they achieve their result – mimicking the performance of the underlying asset or commodity – is increasingly opaque. There’s also a whole species of ETFs that track indices or sectors or futures prices and give you extra leverage.

For example the ProShares family of ETFs slices and dices the market in a massive variety of ways. This gives you a lot of (not necessarily useful) ways to make specific bets on specific sectors in the market. This is why we called ETFs “precision guided investments” when they first came out. The danger with these kinds of complex munitions, however, is that it malfunctions.

The bottom line for ETFs is twofold: they’ve introduced liquidity into commodity markets and made it easier for institutions to go long precious metals without betting on stocks. For retail investors, ETFs are to the 21st century what mutual funds were to the late 20th century – the de facto way to invest in the market.

But nothing, in our opinion, beats getting the big trends right. It’s the asset class that matters. From there, you can seek alpha (superior stock selection.) But if you really want superior leverage, junior mining stocks give you all that and a bag of chips. What’s more, the precious metals miners are in the right big trend (long stuff, short paper money).

Granted, not of that tells us if the mining stocks will be a good refuge in a double dip recession. Probably not. And if last week’s thesis is right that Chinese resource demand has already reached its zenith, you’d certainly be wary of base metal prices and base metal stocks. But what should you do? We’re off to ask the research cabal what they think. Until tomorrow…

Dan Denning
for Markets and Money

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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2 Comments on "Trade Deficit Still High by Historic Standards"

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Nice article DD

Ned S
China … “the national government is responsible for debt equal to over 70% of 2009 GDP. That doesn’t count any loans generated this year that might go sour amid a 30% increase in debt balances nationwide.” And you thought the US had it bad, with a current 50% of GDP debt load…No wonder that Forbes goes on to note: “Signs of the times: government bureaucracies funding themselves by foisting debt on state-owned business enterprises; local governments raising capital by selling land at sky-high prices to corporations they own; and a People’s Bank of China lavishing liquidity on the entire system… Read more »
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