–Just a day after speculating on the 2011 prospects for precious metals, we opened today’s paper to find they had been punched firmly in the nose by profit-taking traders. Comex gold fell back 3.1% and under US$1,400 while silver slipped under $30 and fell by 5.1% in futures trading.
–Here in Australia markets are lower on very thin volume. The miners are down, which is about what you’d expect with commodities taking it on the chin overnight. There is also the continued speculation about how big an affect the floods in Queensland will have on export earnings (and Queensland’s own budget deficit).
–The day-to-day changes in commodity prices aren’t a really big deal. The “really big deal” is whether commodities are overbought, given what the world economy is actually doing to do in 2011. Gold, oil, copper, silver, wheat, rice and other commodities soared in December. But now traders are taking profits. So is this a good time to establish a position if you don’t already have one?
–Well, one key to this mystery is figuring out what rising bond yields mean. U.S. Ten-year Treasury yields have risen since October. This is a key indicator of the expectations investors have about inflation. When bond yields rise, investors expect inflation.
–But this still doesn’t quite unravel the mystery. Rising bond yields that anticipate inflation could be interpreted bullishly. It’s investors summing up the economy and seeing more growth ahead. They sell fixed income and rotate, in text book fashion, into equities. In this context, rising bond yields are nothing to worry about. They’re actually a good sign!
–But are they really? The U.S. government deficit has just eclipsed $14 trillion. Bloomberg reports that governments in Europe have to refinance over $1 trillion in debt 2011. When you keep those numbers in mind, then rising bond yields are the bond vigilantes way of saying, “inflation is coming and it’s not because of a good economy…it’s because of rising deficits and bad fiscal and monetary policy.”
–One vote in the inflation camp is Warren Buffet. Berkshire Hathaway has recently sold $1.5 billion worth of fixed rate debt in order to put to death $1.5 billion in variable rate debt. You’d only do that if you were worried that interest rates could rise quickly and ruinously.
–Right now, though, everything seems to be trundling along quite nicely. You’d never get the impression that the financial system remains weak and one crisis away from another big liquidity/solvency shock. That remains a big threat in 2011 though.
–The big threat to Australia from an external interest rate shock is that the country has trouble financing its chronic current account deficit. Commodity exports generate national income. But the country imports so many other consumer and manufactured goods (not to mention money for banks to lend into the housing boom) that the global cost of capital is a key issue for Australia’s future prosperity.
–One long-term solution to this capital dependency, according to Stephen Grenville via Business Spectator, is to turn the windfall profits of the miners (who obviously have no use for them) and turn it into a sovereign wealth fund (SWF). That SWF can be like a little government slush fund for those times when budget deficits rear their ugly head.
–Of course, many countries are using SWFs as tools of national grand strategy. Today’s Chanticleer article in the AFR reports that SWFs have over $4 trillion in combined assets globally. China’ SWF, the China Investment Corporation, has over US$300 billion, some of which you’d reckon would find its way into Australian coal, iron ore, bauxite and other minerals.
–But to be honest, Australia would have a trifling SWF if it chose to fund it via a tax on resource profits. After all, commodity price cycles are…well…cyclical. They go up. They go down. And that’s not including the fluctuations in supply and demand that affect price and government royalty revenue, as Queensland’s government is now finding out with disrupted coal royalties.
–No…the irresistible asset pool in Australia is in retirement funds via the compulsory contributions you make as a worker. Global pension fund assets are $24 trillion, according to the AFR. In Australia, retirement assets are over $1 trillion. That’s too much money for a government to ignore.
–If you want to know how your retirement assets might be seized by the State to finance deficits or transfer payments, look no further than Eastern Europe and countries like Bulgaria, Hungary, and Poland. The Christian Science Monitor reports how European governments are turning to the last large pools of capital available that don’t need to be borrowed when they can simply be seized.
–Australia’s government finances are certainly not so dire, yet. The terms of trade remain high as does the Reserve Bank of Australia’s index of commodity prices. With the Aussie dollar above parity and the resource revenue rolling in, Australia’s huge foreign debt doesn’t seem like such a problem. And a retirement crisis driven by surging government liabilities and falling revenues seems remote, if not downright impossible.
–But if you wanted to watch for one big trend elsewhere this year that might eventually show up here it’s this: when nation states fight back against insolvency and resist debt restructuring or austerity, cutting public pension benefits and monopolising access to retirement assets is one-two combination you can expect to happen.
–Where capital goes in that kind of environment – if in fact it’s allowed to move anywhere at all – is a great question. We’ll take it up again tomorrow. Until then…
for Markets and Money