Aug

12

Phil McDThe Shanghai Composite Index (^ssec or 000001.ss) peaked at 6124 in October of last year. Since that time it has fallen to about 2500, a drop of about 58%. Yesterday it dropped about 5%. For perspective this decline is almost twice as great as the roughly one third decline in the US in the 1987 crash. Yahoo! has  a one year chart of the damage.

It is noteworthy that this decline comes at a time of great national pride - the coming of the Olympics to China. But in a sense this may be part of the problem. In a clear display of where Chinese governmental priorities are they shut down many factories and production in order to mitigate their extreme pollution problems. Chinese pollution is thought to be the worst in the world. So it was a classic Chinese act to save face at the expense of making money. It also sends the clear message that China's new found capitalism is expendable if it embarrasses the regime in any way.

The attempt to curb pollution had several effects on world wide markets. China's import of crude oil fell in July. This coincided with the recent all time top in crude and subsequent rapid decline from 145 to the recent 112 area. China is the second largest importer of oil in the world. It is clear that the Chinese factory shut down has had significant worldwide implications. But presumably it is only temporary.

The Olympics end August 24th.

Dr. McDonnell is the author of Optimal Portfolio Modeling, Wiley, 2008


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9 Comments so far

  1. michael bonderer on August 13, 2008 12:52 pm

    Iran Sells All Oil Held in Floating Storage Tanks, Shana Says

    Aug. 13 (Bloomberg) — Iran sold all the crude it held in floating storage tanks, Shana reported, citing Ali Asghar Arshi, manager for international affairs at the National Iranian Oil Co.

    Arshi said oil stockpiles built up as refineries underwent seasonal maintenance work and were sold at a higher price as crude rose in recent months, the state-run news agency reported.

    Last Updated: August 13, 2008 02:18 EDT

  2. Darren Reed on August 13, 2008 9:02 pm

    Phil, an excellent point. Please be aware though that the industry shutdown surrounding Beijing is apparently for the duration of the Olympics and the Paralympics, which end on Sep 17th. Then October 1 is National Day, part of two annual “Golden Weeks” which are national seven day holidays. Spoke to a chinese family friend and she said everyone will be off for at least a week, most government officials will take at least 8-10 days off. Would be interested to hear from others here if this is indeed the case. This would seem to point towards a return to commodities bullishness mid October, given that a large proportion of Northern Hemisphere fundies will then be back at their posts.

  3. Greg Vinately on August 14, 2008 8:16 am

    "This would seem to point towards a return to commodities bullishness mid October"

    Folks! Trees don't grow to the skies. Given the fact that commodities have been in a multi-year bull run without any meaningful periods of correction and that the Baltic Dry Index is plunging…how much upside can we expect from here?

    European fundamentals on a straight decline on the heels of geopolitical turmoil between Russia and Georgia does not bode well for the Euro and British Pound. Also rising differences among EMU countries due to disparities in economic growth and ECB policy.

    Japan headed into recession and the rest of Asia (especialy emerging countries) showing rates of inflation surpassing economic growth rates. There is a clear shift in policy taking place in these countries as they cut subsidies and fight inflation in an attempt to decelerate economic growth.

    US consumer stretched in debt and falling housing prices along with a period of credit deflation. Risk being repriced as hedge funds fall from a cliff and credit markets still in turmoil as MBS get pounded once again.

    How much upside for commodities do we see from here? Once the leveraged bets are washed out, hedge funds are purged and the balance sheets of consumers and lenders are cleared…then we can focus on more sustainable long-term upside.

    One more thing….before this is all over and done there will be plenty of Lobagola that will take place in commodities.

    The market is giving clear signs of Lobagola across the board if one looks carefully at commodity related stocks particularly speculative plays in ethanol, solar, nuclear and the like.

    I would not be a bit surprised if the biggest Lobagola takes place in the crude oil market where the speculative binge only paid attention to one side of the equation: supply. It is now time for the demand variable to take hold and it should not be pretty…

  4. rocky on August 14, 2008 3:07 pm

    Greg:
    Very good observations. We're obviously on the same side of this trade (for now at least).

    Adding to the bearish commodity story is the sudden appreciation of the dollar. I know this is hard to believe, but I've been long the Euro (in varying sizes) since April, 2006 (1.26), and only disciplined trading rules have kept me in the trade — as the Euro is grossly overvalued fundamentally. If we keep trading under 1.4840-ish, I'll be exiting the very last of my long Euro position … and trading it aggressively from the short side … as the fundamentals AND technicals are now in alignment. As many slow trend-followers use similar methodologies it would not surprise me to see the Euro waterfall back to 1.20 … before the end of 2008! A perceived (or real) Obama victory could be a possible "catalyst" for a lovefest from the foreigners?

    Here are a couple of more thoughts:
    Real interest rates are still negative. On one hand, that should be supportive of gold and other hard asset prices. However, the conundrum is that real interest rates are negative precisely because of the appreciation of commodity prices. Since this is a circular logic, it could result in falling commodity prices …. resulting in positive real interest rates … which leads to falling commodity prices… This conundrum also debunks the myth that we need super high real rates (ala 1982) to break the commodity bull market. However, I'm not completing discarding the Jim Rogers Super Cycle Grand Kahuna Commodity Bull Market theory quite yet. Here's why: Remember the Super Cycle in stocks began in 1982 and it took 5 years of parabolic prices before the first major correction (1987). Then after digesting the 87 Crash for a year, the bull market resumed….and lasted another 13 years!

    So, for now (for fundamental and technical reasons), I'm betting that we going to be surprised at the magnitude and duration of this commodity price decline. However, I'm also open-minded that at some point in the next 6 to 12 months, the secular bull market may resume — but hopefully, from much lower prices.

  5. Mark B. on August 14, 2008 4:20 pm

    I can confirm that according to Xinhua, the state-run news agency, the shutdowns in Tianjin will be from July 25th to Sept. 30th, concluding after the end of the Paralympics in Beijing.

  6. Chris Carolan on August 14, 2008 10:51 pm

    I am skeptical of any forecast that a balloon will be repaired following its collision with a pin. The trading action in crude oil continues to suggest that perhaps its not just longs who were caught up in Goldman’s $200 bbl mantra, but perhaps producers too, who in normal times would have sold future production hand over fist into a vertical price spike.

    I’m glad Phil didn’t suggest that the 19% decline in gold in one month isn’t a result of China’s completing its manufacturing of olympic medals. Yet the fact remains, the gold and oil declines are hand in hand.

  7. George Parkanyi on August 15, 2008 12:58 am

    Hi Rocky and Greg,

    I’m bearish on commodities as well, bit it’s not going to be a straight line. That’s why a couple of days ago I finally hedged in my naked short gold and short oil ETFs with small opposing long positions. (I’ve been simultaneously both long and short natural gas and grains ETFs, each side now having had a winning streak and a deep drawdown).

    Commodities are still susceptible to shortages from weather, natural disasters, and political events, so I would expect to see high volatility along the way whatever the broader trend. It will be tough for directional traders. All the recent talk about stops in the last few posts is topical. :)

    I think the easy money’s already been made on the short side. It’s still there, but now it’s going to take a little stress to get it.

    And I do think we need to be careful what we wish for. Commodities was the last boom. I don’t see anything else out there booming at the moment. I’m not sure we necessarily want de-flation….which … of course is to be BALLYHOOED … Victor … Laurel … goes without saying, pfffh - deflation, mentioned yes, but most definitely ballyhooed. Uh, that’s my story and I’m sticking to it. :)

    Cheers,
    George

  8. Greg Vinately on August 15, 2008 9:28 am

    Rocky:
    I agree with your observations and I also do not discount the possibility that commodities might be in for a multi-decade run. I’m also not surprised to hear about your long position on Euro since the 1.26 level as I was recently long of gold and other commodity investments for more than 4 years. Discipline and humility in this business are essential tools for survival along with quantitative and qualitative measures to guide you through the volatile ups and downs of the market. I try to stick to this mantra on a daily basis with the perfect understanding that the market can slap me in the face at any moment.

    It is interesting that you mentioned Mr. Rogers and his inclination towards a super cycle bull run in commodities. But it is also interesting to note his recent sentiment shift (several weeks ago) to go long airlines in the midst of worldwide bankruptcies in the group. Such call was not highly publicized by the media, but such sentiment shift can be simply understood as a synthetic short of crude oil. Also of interest were the price moves across the board in the commodity spectrum which surpassed well beyond 2 std. deviations when measured by means of rude and crude historical volatility readings. Also relative strength rankings of nearly 100+ industry groups in equities crossed my desk showing that astute investors were dumping the commodity trade well in advance of the big purge. So the signs were all on the wall for a correction…and how long will it last? I have no idea…but I’ll patiently wait for the next opportunity.

    George:
    There is not much out there booming so to speak as we continue to reprice risk. Can you imagine, the street finally realized that “risk” exists? However, the long term fundamental picture tell us that one should carefully look at the forces of supply and demand of our beaten down healthcare sector. While the sector will continue to fluctuate to the vagaries of whether we have a Democrat or Republican in the White house we continue to see a steady erosion and deterioration of our healthcare infrastructure. We continue to build roadblocks and rigidities into the healthcare system and thus killing supply. Eventually what will slap us in the face will be a massive wave of demand which will soon hit the system (in the next 5-7 years) at an accelerating pace. So in the interest of full disclosure we have been diligently accumulating health care stocks at every big market dump for the past 5 years.

  9. George Parkanyi on August 15, 2008 8:47 pm

    Hi Greg,

    I also like the healthcare theme. I’m not all over it, but I have enough in the portfolio to make a difference. With my system I hold fixed names and simply reallocate between them based on relative price movement of the individual securities (not asset classes as a whole). They are organized into groups, but in general whichever goes up the most I sell a little of; whichever goes down the most I buy with the proceeds - and I don’t worry about the absolute profitability of individual trades. (The effect at work is compounding of share count - which works in any market.) I don’t predict anything, I just react to signals based on simple price divergence. (The one certainty in the market is that stocks and commodities fluctuate, so that’s where I focused my research and on which I developed my system.)

    The main themes I work with are commodities through 2x leveraged ETFs (both long and short), technology, financials, healthcare, and a mix of energy, alternative energy, infrastructure, and a few odd and ends. I mitigate risk with about an 8-10% exposure to a variety of 2x short equity index ETFs. This makes for a good (internal) volatility cocktail while keeping the overall portfolio very stable (while grinding higher - at least since I’ve got the mix right). My fixed health names have been in the dumps for a while but are perking up, the techs are mixed, the energy and commodities are wild and crazy but participating nicely, and the financials are doing not all that badly actually. I’ve accumulated a lot of the ProShares 2x Financials ETF (UYG) on the way down, still under water a bit, but then have chipped off some of that after the big surge last month. The equivalent health care ETF (RXL) is nicely above water and has already contributed some capital to other purchases.

    If I were to add to the portfolio, I’d definitely be poking around amongst the health stocks. I think there’s good value there, and as you point out, the boomers aren’t getting any younger.

    Cheers,
    George

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