The Great Debate

A shifting global economy brings Australia to a crossroads

Australia is no longer immune to the stagnation in the West. Despite a resilient housing market, Australia’s economy is slowing. With a worsening labor market, consumption is eroding, along with business confidence.

In the past two years, the benchmark interest rate has been almost halved to 2.5 percent. Still, Australia’s real GDP growth is likely to decrease to 2.4 percent during the ongoing year and will remain barely 2 percent until the mid-2010s.

Australia is at a new crossroads.

In the past decade or so, exported commodities fueled Australia’s terms of trade, thanks to rising commodity prices. While agriculture and natural resources each account for barely 3-5 percent of GDP respectively, they contribute substantially to export performance. True, the service sector of the economy, including tourism, education, and financial services, continues to account for some 70 percent of GDP. However, the country’s abundant and diverse natural resources attract substantial foreign investment.

Before the global financial crisis, the Australian economy grew for 17 consecutive years. As export-led growth collapsed worldwide, then-Prime Minister Kevin Rudd’s Labor government introduced a US$50 billion fiscal stimulus package to offset the effect of the slowing world economy, while the Reserve Bank of Australia (RBA) cut interest rates to historic lows. Further, China’s 2009 stimulus package sustained demand for commodities from Australia.

Except for just one quarter of negative growth, Australia actually grew by 1.4 percent in 2009. Last year, growth amounted to 3.3 percent, whereas unemployment was 5.2 percent. However, despite past efforts to refocus on increasing economic productivity, Australia’s growth has been driven somewhat narrowly by a mining investment boom, which has rendered the economy more vulnerable to trade shocks.

An agenda to boost Africa’s economy

A lot can happen in a year. This time last year, U.S. businesses and NGOs bemoaned the Obama administration’s perceived indifference to Africa. Now, they’re trying to find out how to catch the wave of interest. Major new initiatives, including Power Africa and Trade Africa, unveiled during President Obama’s first true trip to Africa this summer, as well as a reinvigorated push to renew the African Growth and Opportunity Act fully two years before it’s due to expire, have given U.S.-Africa watchers a lot to consider. But what — and when — is enough for U.S. policy in Africa? What more can be done in the year ahead? How do things really shake out for investors, civil society and Africans? Here are three additional areas the Administration should consider as it deepens its commitment to the continent:

1. Invest in Africa’s equity and commodity markets. ­Despite all the interest in Africa’s economic growth and investment potential, it’s still very hard to invest on the continent. Of its less than 30 stock markets, only a few exchanges really offer modern processes and back-end technology to facilitate daily transactions. As Todd Moss from the Center for Global Development notes in a recent paper, some African exchanges trade less in a whole year than New York does before “their first coffee break.” As a result, for institutional investors who need to take large positions or who have fiduciary requirements for daily liquidity, Africa remains almost entirely off-limits. In an era of algorithmic and high-speed trading, Africa’s antique market infrastructure is a major barrier to entry for much needed foreign direct investment.

Innovation is perhaps most evident in commodity exchanges. A number of projects in East Africa are taking off — including the East Africa Exchange (EAX), a private initiative founded by Heirs Holdings, Berggruen Holdings and 50 Ventures, which was launched in January this year. The eponymous Eleni LLC, a consultancy focused on developing private exchanges, builds off the rapid success of Ethiopia’s commodity exchange and the work of Eleni Gabre-Madhin, its founder. Both efforts build the critical architecture necessary for productivity growth in economies that still remain predominantly agrarian.

Quantitative easing and the commodity markets

-The views expressed are the author’s own-

A warning by an International Energy Agency (IEA) analyst this week that quantitative easing (QE) risked inflating nominal commodity prices and derailing the recovery drew a withering response from Nobel Economics Laureate Paul Krugman, who labelled the unfortunate analyst the “worst economist in the world”.

According to New York Times columnist Krugman “Higher commodity prices will hurt the recovery only if they rise in real terms. And they’ll only rise in terms if QE succeeds in raising real demand. And this will happen only if, yes, QE2 is successful in helping economic recovery”.

Krugman’s criticism is unfair. There are clear links between QE and investor appetite for commodity derivatives and physical stocks (via the Federal Reserve’s “portfolio balance” effect), and from investors’ holdings of derivatives and physical inventories to cash prices (given the relatively inelastic supply and demand for raw materials in the short term).

Wanted: more commodity hedgers

For the last decade, investors such as pension and hedge funds have been the fastest-growing segment of commodity derivatives markets. The most successful banks and dealers have been those which marketed themselves most effectively to this new group of customers.

In the next five years, however, expanding the use of derivatives as hedging instruments for producers and consumers will re-emerge as the priority area. Banks and dealers will be searching for natural counterparties for all the pension funds and hedge funds wanting to use futures and options as a source of returns, diversification and inflation protection.

Separating derivatives users into “hedgers” and “speculators” is notoriously hard. Problems with the U.S. Commodity Futures Trading Commission (CFTC)’s classification of commercial and non-commercial users are well-known. Even the more detailed categories contained in the new disaggregated commitments of traders reports are not completely satisfactory.

Roll losses swallow up commodity inflows

Total assets under management in commodity-tracking indices and exchange-traded products (ETPs) have stalled over the last nine months, as roll losses swallow up fresh money inflows.

There has been little change in total money committed to index-like investments or its distribution between long and short positions, according to the latest quarterly figures released by the U.S. Commodity Futures Trading Commission (CFTC) yesterday, which show positions as of 30 June 2010.

The data is based on a special call sent to all known index operators and firms offering futures and options-based exchange-traded products. It is the most comprehensive measure of total funds under management in the passive sector, but excludes physically backed ETPs such as the popular SPDR Gold Trust .

from The Great Debate (Commentary):

Commodities should be short-term investments

Commodity indices and exchange-traded products (ETPs) should be regarded as short- to medium-term investments rather than long-term strategies, as a quick glance at performance over the last 10 years shows.

Their value lies in providing simplicity and liquidity for retail investors and institutions such as pension funds, which do not want the complexity of managing futures positions with their daily margin adjustments and rollovers.

They also permit institutions and retail investors forbidden from investing in derivatives to gain exposure indirectly by repackaging derivatives as swap transactions or embedding them in structured notes, which resemble debt or equity securities.

Goldman slashes risk-taking in commodities

John Kemp is a Reuters market analyst. The views expressed are his own

Goldman Sachs cut the amount of risk it staked on commodity trading during Q2 2010 by almost 35 percent, part of a broad-based reduction in risk across the bank’s trading book. Value-at-risk (VaR) linked to commodity prices fell to an average of just $32 million per day between April and June, down from $49 million in the prior quarter and $40 million in the same period a year earlier, according to the firm’s earnings release. Cuts in VaR allocated to commodities were in line with reductions elsewhere, including interest rate risk (down just over 20 percent) and equities (down just over 30 percent). Only currency trading saw a slight increase in risk taking (up 3 percent). Commodity VaR was reduced to its lowest level since the three months ended September 2009, and before that November 2007.

Goldman has been reducing firm-wide VaR (net of diversification) since the middle of 2009 — shortly after the firm converted to Bank Holding Company (BHC) status regulated by the Federal Reserve, subsequently changed to Financial Holding Company (FHC) status, rather than its previous incarnation as a securities firm. Gross VaR (excluding diversification) started dropping after Q3 2009 (when it peaked at a massive $416 million). Gross VaR now stands at a more modest $272 million (down 35 percent). The firm’s massive interest rate risk (which peaked at $218 million in Q1 2009) has been cut to less than half that ($87 million in Q2 2010). But the April-June quarter was the first time the de-risking process had extending to commodities.To some extent, VaR is endogenous. Unless position limits are changed to offset it, VaR naturally rises and falls with market volatility. But firms can always over-ride fixed limits to keep VaR “budgets” unchanged despite changes in volatility if managers decide it is worthwhile.

What is notable is that market volatility rose during Q2 2010 in most asset classes (including commodities) after a quiet Q1. Yet Goldman’s VaR measures declined almost across the board, suggesting a deliberate policy to cut risk. Opportunities to generate revenue by taking market risk appear to be declining across the company’s trading operations. One crude measure of the firm’s “trading efficiency” is the amount of dollars it generates in net revenue for every $1 put at risk (VaR). Trading efficiency peaked at $46 for every $1 risked at the start of 2007 and has never recovered to the same level. Efficiency in Q2 2010 was just 24:1, down from 32:1 in the prior quarter, and less than half the peak (Charts 4 and 5).

The darkest period before dawn?


Abandon hope all ye who enter here was the inscription written above the gates of Hell in Dante’s Divine Comedy.

Investors who decided to take a long position in commodity futures at the start of 2010 anticipating a global recovery, tightening supply-demand balances, and rising prices, could be forgiven a sense of despair.

Their risk-taking has been rewarded with range-bound prices and a contango eating deeply into returns. Most longs lost money in H1 2010.

from The Great Debate UK:

Facebook group defends “harassed” BP


BP’s chief executive Tony Hayward branded “the most hated man in America” may be surprised to find himself cast in the role of victim by a growing clan of web-based supporters on Facebook.

One such group ‘Support BP’ calls itself the defender of an “undeservedly harassed institution” and seeks to show that the public opprobrium BP faces over its now 60-day-old Gulf of Mexico oil spill is not universal.

Members have been increasingly vocal since a succession of strong rebukes of BP by U.S. President Obama and lawmakers at Thursday’s congressional hearing, which they are calling a “lynch mob”.

Anti-Keynesians and falling commodity prices

Policymakers’ new enthusiasm for cutting budget deficits will slow growth across the advanced industrial economies, cutting the outlook for commodity consumption and prices over the next 2-3 years.

For the past year, investors and commentators have been trying to guess how quickly extraordinary stimulus provided during the 2008-2009 crisis would be withdrawn.

Most attention focused on the timing of interest rate increases and measures to mop up excess liquidity provided by central banks. Instead tightening is set to commence from the fiscal side.