Download GoldCore Outlook For 2014

CONTENTS
– Introduction
– Review of 2013
– Gold and Silver Have Torrid Year – Fall 27% and 35% Respectively
– Year Of Paper Selling But Robust Physical Demand – Especially From China
– Highlights Of Year – German Gold Repatriation, Record Highs In Yen, Huge Chinese Demand
– Lowlights Of Year – Massive Paper Sell Offs in April/June and Cypriot Deposit Confiscation
– Syria and the Middle East
– U.S. Government Shutdown and $12 Trillion Default Risk
– Continuing Central Bank Demand
– Regulatory Authorities Investigate Gold Rigging

Outlook 2014
– Geopolitical Tensions – The Middle East, Russia, China, Japan and the U.S.
– Ultra Loose Monetary Policies Set To Continue with Yellen as New Federal Reserve Chair
– Eurozone Debt Crisis Again – UK, U.S. Japan and China Also Vulnerable
– Enter The Dragon – Chinese Gold Demand Paradigm Shift To Continue
– Death Of Indian Gold Market Greatly Exaggerated
– Long Term (2014-2020) MSGM Fundamentals

Conclusion

Introduction
Happy New Year. We would like to take this opportunity to wish our clients and subscribers a prosperous, healthy and happy 2014.

With 2013 having come to a close, it is important to take stock and review how various assets have performed in 2013, assess the outlook in 2014, and even more importantly, the outlook for the coming years.

2013 was the year of the speculator and the year of the risk asset, such as equities, with global stocks doing well in the sea of liquidity and cheap money created by central banks.
Surprisingly to many gold bulls, these favourable monetary conditions did not lead to higher precious metal prices. Gold and particularly silver had a torrid year and significantly underperformed the vast majority of equity and bond markets.

The MSCI World Index was up 23% and the S&P 500, the Nasdaq and the FTSE were up 32%, 35% and 14% respectively.

MSCI World Index – 1970 to January 3, 2014 – Bloomberg

Bond investors did not fare as well as interest rates began to rise from all-time record lows. As bond prices fell, interest rates rose. The bellwether 10-year Treasury note closed the year at 3.028%, which was up from 1.76% at the start of 2013 and the highest since July 2011.

US 10 Year Note – 1964 to January 3, 2014 – Bloomberg

The Barclays US Aggregate bond index, which is dominated by Treasury, mortgage and corporate bonds and is the leading benchmark followed by institutional money, is set to record its first negative year of total returns since 1999. The bond market’s major benchmark registered a total return of minus 2.1% for 2013. It is only the benchmark’s third annual negative total return since 1976, according to Barclays.

REVIEW OF 2013

Gold and Silver Have a Torrid Year – Fall 28% and 36% Respectively
Gold fell in all major currencies in 2013 and fell 28% in dollar terms for its first annual price fall since 2000. Gold fell 40% in pound terms, 45% in euro terms. Gold fell much less in Japanese yen terms and was 16% lower in yen as the yen continued to be devalued and debased.

Silver was down by 36% in dollar terms and by more in the other currencies; silver had its poorest annual performance since 1984.

Gold came under pressure in the first half of 2013 and saw falls from near $1,700/oz at the start of the year to $1,180/oz by mid-year. Indeed, gold’s low for the year took place on June 28th, which was the last day of trading in Q2, and an important time frame for those evaluating gold’s longer term performance.

The price falls in the first half took place despite a positive fundamental backdrop and despite the risk of contagion in the Eurozone – especially from Spain, Italy and Greece. This risk was so great in the early part of the year that it led George Soros to warn in February that the Eurozone could collapse as the U.S.S.R. had.

In March, Cyprus was the first country to experience a bank bail-in of depositors, where both individual and corporate account holders, experienced capital controls and a confiscation of nearly 50% of their deposits. In June and then again two weeks ago, the EU confirmed that depositors will be bailed in when banks are insolvent.

International monetary and financial authorities globally, including the ECB, the Bank of England and the Federal Deposit Insurance Corporation (FDIC), have put in place the regulatory and legal framework for bail-in regimes in the event of banks failing again.

Are Your Savings Safe From Bail-Ins

Gold saw a bit of a recovery in the third quarter with gains in July and August as gold interest rates went negative, bullion premiums in Asia surged and COMEX inventories continued to fall. Silver surged 12% in 5 trading days in mid August due to record silver eagle coin demand and ETF demand.

UK gold ‘exports’ to Switzerland increased greatly during the year due to demand for allocated gold in Switzerland due to Switzerland’s tradition of respecting private property throughout the centuries and its strong economy. However, more importantly, UK gold exports to Switzerland were due to the significant increase in store-of-wealth demand from China and many countries in Asia.

Institutional gold in the form of London gold delivery bars (400 oz) was exported to Swiss refineries in order to be recast into one kilogramme, 0.9999 gold bars used on the Shanghai Gold Exchange and in the Chinese market.

However, this was not enough to prevent further falls in the final quarter and in recent days when gold has again tested support at $1,200/oz.

Year Of Technical, Paper Selling But Robust Physical Demand

German Gold Repatriation
The year began with a bang, when news broke on January 17 that the German central bank was attempting to repatriate Germany’s gold reserves. The Bundesbank announced that they will repatriate 674 metric tons of their total 3,391 metric ton gold reserves from vaults in Paris and New York to restore public confidence in the safety of Germany’s gold reserves.


Bundesbank – Goldbarren

The repatriation of only some 20% of Germany’s gold reserves from the Federal Reserve Bank of New York and the Banque of Paris back to Frankfurt was meant to allay increasing German concerns about their gold reserves. But the fact that the transfer from the Federal Reserve is set to take place slowly over a seven year period and will only be completed in 2020 actually led to increased concerns. It also fueled concerns that the unaudited U.S. gold reserves may be less than what is officially recorded.

What was quite bullish news for the gold market, saw gold quickly rise by some $30 to challenge $1,700/oz. The news was expected to help contribute to higher prices but determined selling saw gold capped at $1,700/oz prior to falls in price in February.

Paper Selling On COMEX
Gold’s falls in 2013 can be attributed in large part to paper selling by more speculative players on the COMEX. This was graphically seen in April when there was a selling raid on the COMEX which led to a huge price fall of nearly 15% in two days prior to the emergence of “extraordinary” demand for gold internationally.

The sell off came as demand in Europe began to pick up due to concerns that the Cypriot deposit confiscation may be a precedent that could be seen in other EU countries.

The speed and scale of the sell off was incredible and even some of the bears were surprised by it. Many questioned the catalysts for the $150 two day sell off. The sell off was initially attributed to an unfounded rumour regarding Cyprus gold reserve sales – this was soon seen to be a non-story. The Cyprus rumour did not justify the scale of the unprecedented sell off.
Reports suggested that a single futures sell order worth $6 billion, equal to 4 million ounces or 124.4 tonnes of gold, by a large investment bank sent prices plummeting. The futures market then saw a further wave of selling of contracts worth some $15 billion, equivalent to 10 million ounces of selling or 300 tonnes, in just 35 minutes.
Gold futures with a value of over 400 tonnes were sold in a handful of trades in minutes. This was equal to 15% of annual gold mine production. The scale of the selling was massive and again underlines how one or two large banks or hedge funds can completely distort the market by aggressive, concentrated leveraged short positions.

Investment banks and hedge fund speculators can manipulate the paper or futures gold price in whichever direction they want in the short term due to the massive leverage they can utilise. The events in April further bolstered the allegations of manipulation by the Gold Anti-Trust Action Committee (GATA).

Significant Demand For Physical Gold Globally
Gold prices fell very sharply despite very high demand. However, the gold price decline was arrested by the scale of physical demand globally. This demand was particularly strong in the Middle East and in Asia, particularly China but was also seen in western markets with government mints reporting a surge in demand in 2013.

This demand for physical gold was seen in western markets throughout the year. In April, the US Mint had to suspend sales of small gold coins; premiums for coins and bars surged in western markets due to high demand.

Mints, refineries and bullion brokerages were quickly cleared out of stock in April and COMEX gold inventories plummeted. There were gold and silver coin and bar shortages globally.

This continued into May as investors and savers globally digested the ramifications of the Cypriot deposit confiscation. The crash of the Nikkei in May also added to physical demand in Japan and by nervous investors internationally.

This led to all time record gold transactions being reported by the LBMA at the end of May.

Chinese demand remained very robust and Shanghai Gold Exchange volumes surged 55% in one day at the end of May – from 10,094 kilograms to 15,641 kilograms. There were “supply constraints” for gold bars in Singapore and bullion brokers in Singapore and India became sold out of bullion product at the end of May.

This, and concerns about a very poor current account deficit and a possible run on the Indian rupee, prompted the Indian government to bring in quasi capital controls and punitive taxes on gold in June. Ironically, this led to even higher demand for gold in the short term and much higher premiums in India. Longer term, it has led to a massive surge in black market gold buying with thousands of Indians smuggling in gold from Bangkok, Dubai and elsewhere in Asia.

June saw another peculiar sudden 6% price fall in less than 24 hours. This again contributed to increased and very robust physical demand. U.S. Mint sales of silver coins reached a record in the first half of 2013 at 4,651,429 ounces and the UK’s Royal Mint saw a demand surge continuing in June after demand had trebled in April.
Asian markets continued to see elevated levels of gold buying. Gold demand in Vietnam was so high that buyers were paying a $217 premium over spot gold at $1,390/oz. Premiums surged again in China as the wise Chinese ‘aunties’ and wealthy Chinese continued to buy gold as a store of wealth.

Despite very high levels of demand for gold, in Asia especially, gold languished and sentiment in western markets continued to be very poor with gold falling to the lows of the year on June 28th.

July saw continuing strong demand for gold internationally as volumes surged to records on the Shanghai Gold Exchange (SGE). Premiums rose and feverish buying left many of Hong Kong’s banks, jewellers and even its gold exchange without enough gold bullion to meet demand.

In August, demand remained elevated and gold forward offered rates (GOFO) remained negative and became more negative. This showed that physical demand was leading to supply issues in the highly leveraged LBMA gold market or the institutional gold bar market.

Today, as we enter the New Year gold, forward offered rates (GOFO) remain negative, meaning banks, which had lent their customers gold to obtain a positive return, and therefore increase the “paper” gold supply, will take the gold back. This should limit the amount of gold on the market and increase the gold price.

Chinese buyers are of increasing importance but it is important to note that physical demand rose significantly throughout the world in 2013 despite falling prices. This is seen in the levels of demand experienced by leading bullion dealers, refiners and government mints. This is clearly seen in the data released by the Perth Mint and the U.S. Mint which both saw increased demand for physical gold coins and bars in 2013. Other mints have yet to report their numbers.

The Perth Mint of Western Australia reported yesterday that they saw a very significant increase in sales in 2013 despite the falling prices. Gold sales from the Perth Mint, which refines most of the bullion from the world’s second-biggest producer Australia, climbed 41% last year.

Sales of gold coins and minted bars totalled 754,635 ounces in 2013 from 533,333 ounces a year earlier, according to data from the mint.

Silver coin sales surged 33% to about 8.6 million ounces from 6.5 million ounces in 2012, according to the Perth Mint.

Gold bullion sales expanded 12% to 58,944 ounces in December from 52,700 in November and about 51,778 ounces in December 2012, according to data from the mint. Gold sales fell to as low as 30,430 ounces in August and peaked at about 112,575 in April, when gold was hammered 14% lower on the COMEX in just two days.

Silver coin sales were 845,941 ounces last month from 807,246 in November and 452,389 a year earlier, it said.

The U.S. Mint also saw an increase in physical gold sales and sold 14% more American Eagle gold coins last year and sales climbed 17% to 56,000 ounces in December from November, according to data on the mint’s website as reported by Bloomberg.

Syria and the Middle East
Even bullish developments such as the prospect of war in Syria at the end of August, only led to small, short term price gains. War in Syria and in the Middle East, pitching the U.S. and western allies against China and Russia was expected by many to lead to “market panic” and to propel gold “much, much higher,” in the words of astute investor Jim Rogers.

Only the fact that President Obama and the U.S. were confronted with opposition by people internationally against another war and were outmaneuvered diplomatically, prevented the war with Syria.

The war had the potential to destabilise the region with ramifications for oil prices and the global economy.

U.S. Government Shutdown and $12 Trillion Default Risk
Another very bullish development for gold came in late September and early October with the U.S. budget negotiations and government shutdown.

They highlighted the dire U.S. fiscal position and the complete failure of the American political and economic class to deal with their extremely precarious financial position in any meaningful way. The U.S. government is essentially bankrupt with a national debt of over $17 trillion and unfunded liabilities of between $100 trillion and $200 trillion.

In the coming months and years, it will lead to a lower dollar and much higher gold and silver prices.

However, in the year of paper gold selling that was 2013, even this did not lead to higher gold prices.

Continuing Central Bank Gold Demand 
All year, central banks continued to accumulate gold with Russia, Kazakhstan, Azerbaijan, Kyrgyz Republic, Turkey and other central banks continuing to diversify their foreign exchange reserves.


U.S. Federal Reserve employees in underground vault holding monetary gold

Central banks continued to be strong buyers of gold in 2013, albeit the full year data may show demand was at a slightly slower rate than the record levels seen in recent years. Q4 2013 will be the 12th consecutive quarter of net purchases of gold by central banks.

Total official central bank demand continued at roughly 100 tonnes every single quarter. However, this does not include the ongoing clandestine and undeclared purchases of gold by the People’s Bank of China. Conservative estimates put PBOC demand at 100 tonnes a quarter or at over 400 tonnes for the year. More radical projections are of demand of over 1,000 tonnes from the PBOC in 2013.

Regulatory Authorities Investigate Gold Rigging
Peculiar, single trade or handful of trades leading to sudden gold price falls were common in 2013 and contributed to the 28% price fall.

Therefore, those who have diversified into physical gold will welcome the move by the German financial regulator BaFin to widen their investigation into manipulation by banks of benchmark gold and silver prices. In December, the German banking regulator BaFin demanded documents from Germany’s largest bank, Deutsche Bank, as part of a probe into suspected manipulation of the gold and silver markets.

The German regulator has been interrogating the bank’s staff over the past several months. Since November, when the probe was first mentioned, similar audits in the U.S. and UK are also commencing.

Precious metal investors live in hope but their experience of such investigations is that they are often very lengthy affairs with little in the way of outcome, disclosure or sanction. The forces of global supply and demand, one anemic, the other very high, are likely to be more important and a valuable aid to gold and silver owners in 2014 and in the coming years. As ultimately, the price of all commodities, currencies and assets is determined by supply and demand.

Janet Yellen Becomes Fed Chair

At year end came confirmation that cheap money uber dove Janet Yellen was set to take over from Ben Bernanke as Chair of the Federal Reserve. Gold bulls cheered loudly at her appointment thinking that Yellen’s appointment would lead to a recovery in oversold gold prices. However, even this bullish development did not help embattled gold prices.

OUTLOOK FOR 2014

Introduction

2013 was a year of calm in the world of finance. 2014 may not be so calm and there is a risk of renewed turbulence on global financial markets. There are many unresolved risks which were present in 2013 but did not come to the fore and impact markets as they could have.

The Eurozone debt crisis is far from resolved and there remains an underappreciated risk of sovereign crises in other major industrial nations.

There are far more positives for gold than negatives and the positives include ultra-loose monetary policies, risk of sovereign and banking debt crises and systemic or contagion risk, the increasingly uncertain political and military situation globally and of course increased demand for gold from the Middle East, much of Asia and particularly China.

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Original source at: zero hedge - on a long enough timeline, the survival rate for everyone drops to zero | http://www.zerohedge.com/contributed/2014-01-04/good-bad-and-ugly-gold-2013-and-outlook-2014

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SocGen has published a fantastic, must read big picture report, which compares the world in the 1980/1985-2000/2005 time period and juxtaposes it to what the author, Veronique Riches-Flores predicts will happen over the next two decades years, the period from 2005/2010 to 2025/2030. Unlike other very narrow and short-sighted projections, this one is based not on trivial and grossly simplified assumptions such as perpetual growth rates, but on a holistic demographic approach to perceiving the world. At its core, SocGen compares the period that just ended, one in which world growth was driven by an expansion in supply, to one that will be shaped by an explosion of demand. And, unfortunately, the transformation from the Supply-driven to the Demand-driven world will not be pretty. Summarizing this outlook: “Over the last three decades strong growth in the working-aged population across Asia and the opening-up of world trade have led to considerable expansion in global production capacities. These factors created a highly competitive and disinflationary environment of plentiful supply, which was characterised by low interest rates, a credit boom and, in the financial markets, exuberant appetite for risky assets. As the demographic cycle progresses, we are seeing the emergence of an aging population, which is less favourable to productive investment. Meanwhile the rise in living standards among the emerging population heralds an unprecedented level of growth in demand. The world supply/demand balance is dramatically changing against a backdrop of resource shortages which are likely to favour shorter cycles, increased government intervention in economic affairs and inflation.” In other words, contrary to what you may have read elsewhere, the future is about to get ugly. And topping it all off is a Kondratieff cycle chart: what’s not to like. Read on.

Visually comparing the two proposed world paradigms:

The world was characterized by a very defined demographic transformation which served as the underpinning of a production capacity explosion:

A rise in the working age population, which provides labour and growth in demand and savings, has always coincided with economic prosperity. This trend, which economists describe as the “demographic dividend” of the first phase of transition from a primitive or  stationary demographic structure, with high birth and death rates, to a developed demographic structure, translates in economic terms into a very strong urge to invest, which is the main source of economic development. The countries of Asia excluding Japan reaped  spectacular rewards from this demographic transition: between the mid-1980s and the present their rate of investment has increase by the equivalent of more than 10% of the region’s GDP and industrial potential has considerably increased. The surge in investment that began in Southeast Asia has over the last 15 years focused predominantly on China.

Yet demographics must be taken in conjunction with the other core feature defining the world since 1980: the literal New World Order, predicated by the opening of the world to “free trade.”

This transition would not have been so great, nor would it have had the global implications it has had, if it hadn’t been accompanied by the opening-up of world trade due to progress in international negotiations which first brought the GATT agreement and then the WTO, with the aim of optimising resources by making better use of competitive advantages.

In a progressively open world, Asian countries drew increasing benefits from their comparative advantage. The sudden abundance of very low cost labour created the conditions for an unprecedented rise in competition on the world labour market which brought even more investment into the region. What these trends did was to bring about a profound shift in the world’s production and labour balance and a radical change in the economic model that was previously in force. Because, although there had always been cost differences from one country to another, access to a globalised market provided the opportunity of exerting more influence than ever before. The liberalisation of trade gave the Asian demographic transition a dimension comparable to that which brought about the same phenomenon in Europe a century earlier, albeit in Europe’s case the scale was far smaller.

Thus the population boom of recent decades triggered, not a substantial rise in demand, as one might at first expect, but a massive increase in supply as a result of the unprecedented expansion of the global production base. Given that the purchasing power of workers in the emerging Asian countries has, up until recently, been too limited to have any real influence on world demand, average global investment per capita continued to grow faster than real consumption in the region between the mid-1980s and 2007, with the gap peaking at almost 40% over the period.

Naturally, just these two drivers did not nearly come close to explaining the hospitable environment for global growth:

These fundamental characteristics have been reinforced by innumerable other economic, political and cultural revolutions which all aided the development of supply: the end of communism and consequently the expansion of the capitalistic model, privatisations and the widespread decline of state intervention, deregulation in most of the major sectors of economic life, the accelerated development of the financial markets, the revolution of communication technologies. All of these factors contributed to an environment shaped by abundant supply, where increasing competition meant that the least competitive were doomed to fail and all sustained prices rises were eradicated. While the central banks congratulated themselves for having kept inflation under control over the years, we can see that they had a good deal of help from the underlying economy. By restricting access to excess liquidity for the goods markets, the context made it a lot easier for the central banks to control the scourge of inflation. Meanwhile disinflation led to a structural weakening in interest rates which was highly beneficial for the conditions underlying global supply… until it eventually led to the financial excesses that caused the crisis in 2008.

This combination of factors created an environment that was particularly favourable for all asset classes, company assets in the first instance, and then credit, bonds and property assets.

While the expansion of the production platform took place primarily in Asia, it was the West that enjoyed the improvement in return on capital. In a hyper-competitive environment, productivity gains improved in proportion to job weakness and, in a context characterised by a structural decline in capital stock and weaker economic growth, this produced a marked improvement in yield on the latter.

Overall these shifts meant that in the universe of large corporations an increasing part of the added value went towards profits and this, combined with a very strong dividend distribution policy, goes a long way towards explaining the paradox of recent years where structurally weak economies and very strong capital market profitability lived alongside each other for so long.

So that was then. And it lead to what can only be described as log growth in all aset classes: we will not insult readers’ intelligence by showing a graph of the S&P from 1980 to 2005.

What is next?

SocGen does not sugarcoat it:

The unprecedented economic and financial crisis of 2008 has abruptly altered the course of history and there is no doubt that its effects will have a sustained influence on future developments. However, the crisis itself represents the expression of the end of the excess created by the previous situation and its consequences should play only a secondary role in comparison to the powerful structural changes that are currently sweeping across the globe, namely changing demographic trends, the explosion of demand in emerging countries and the resurgence of physical constraints to growth.

The shift in the global demographic structure that has characterised the last three decades is now coming to an end. Although the global population is expected to continue to grow significantly in the future, with the nine billion threshold likely to be reached in 2040  according to the UN’s latest projections, a third of this growth will be attributable to the expansion of the elderly population, in the developed countries of course, but also in a good number of emerging countries, and particularly Asia.

The biggest demographic change is without doubt the aging of global, both developing and developed, society. This also explains the special role insolvent entitlement structures which are supposed to ensure retirmenet and pensions for ever more people, have in the eyes of current governments:

By 2030, the portion of working age people in the industrialised countries is expected to have fallen by more than 5%, from more than 67% of the population today, to 62%. By contrast, the over-65s are expected to climb from 16% to 22.5%. In Asia excluding Japan, the over-65s are expected to account for 36% (277 million) of the population increase, after having accounted for less than 10% of the increase observed over the previous 30 years. In the region, the portion of working people in the total population will stop growing when the Chinese population embarks on a similar decline to the one projected for the developed countries starting in 2010.

The below should be the first refutation of any brainless idiotic argument which sees the Dow at 20,000 in the near future (absent  hyperinflation of course, in which case the Dow will be at 20 billion but be completely worthless).

The economic implications of population growth resulting from an increase in working aged adults in the first case and an increase in over-65s, in the second, are naturally not comparable. While in the first case, the demographic shift favours structural development, in the second case it weighs on development.

The causes are largely understood in the developed countries where the population has already aged considerably. In this case nevertheless, the negative effects that the aging population has on savings and the urge to invest are likely to be accompanied, or even preceded by at least a proportional decline in growth of structural demand, especially in the current context of widespread household/government over-indebtedness. With revenues at least a third lower than those of the working population, the retired population consumes considerably less than the average adult and is far more vulnerable to debt and asset depreciation than younger households. The combined effects of over-indebtedness, property market decline and widespread fiscal tightening are thus likely to be greater in terms of pressure on demand than the effect of demographic aging on supply.

A longer-term demographic snapshot:

By 2030 two-thirds of the needs of the global population will emanate from the emerging world, the population of which is expected to approach seven billion and the economic weight of which is set to double in comparison to today’s level.

The punchline:

So, while up until now less than one billion people have accounted for three-quarters of global consumption, over the course of the next two decades, the new Chinese, Indian, Indonesian, Latin American and African middle classes will bring an additional two billion consumers with similar needs and aspirations as today’s North American, European and Japanese consumers.

Summarized what does this mean: said simply, an explosion in needs manifesting in a huge demand, and shortage, for all sorts of products, both raw and finished.

The global auto market

In 2010 the global auto fleet stood at approximately one billion vehicles. However, based on the increase in revenues per capita and fairly conservative assumptions relating to the increase in equipment ratios in the main emerging countries, the level should  spontaneously double by 2030.

To satisfy these new needs, production is going to have to grow at an average rate of 3.5% per annum over the next 20 years, compared with an average annual growth rate of 2.5% over 2002-2008. Although this may not seem too far-fetched at first, we then have to add the renewal of the existing fleet which, based on an average vehicle lifespan that we estimate to be between 10 and 12 years, will have to be completely replaced over the next two decades. Thus, one billion expansion + 1.6 to two billion replacement, which means that, in comparison to the current level, production would actually have to triple rather than double in order to meet future demand, corresponding to an average annual growth rate of not 3.5% but potentially 4.4% (assuming a 10-year average lifespan of a vehicle) to 5.6% (10 year average lifespan) by 2030.

Metals and other inputs

Given that metal accounts for half of the weight of each new vehicle (54% exactly at present), the tripling of auto production between now and 2030 implies a threefold increase in demand for metals, steel alloys, light metals such as aluminium, and textiles, which are also used extensively in vehicle production.

Meanwhile in another field, namely construction, rapid urbanisation and the subsequent increase in tall buildings is also contributing to very strong growth in demand for steel. According to ENRC (Eurasian Natural Resources Corporation), buildings of over 16 floors, where steel intensity is twice as high as in buildings of less than six floors, are expected to account for more than half of all new Chinese constructions between now and 2020.

These few examples are not just the exceptions. At this stage many sectors are projected to encounter increased demand of similar proportions, as the change in lifestyles that accompanies the rise in living standards in the emerging countries affects demand for a considerable range of goods.

Beyond growth in demand for finished products, the most spectacular effect likely to be brought about by the stronger development of the emerging economies will be the enormous rise in demand for raw materials.

The full report (below) indicates the same squeeze in agircultural products and in energy. Yet the take home message is clear: resource shortages are coming back with a vengeance as physical limits on growth once again appear.

Having disappeared from the economic landscape over the last century, resource shortages are back. This will create a particularly unstable environment in the long term, some of the characteristics of which we can already anticipate:

Structural increase in the cost of raw materials. A structural increase in raw materials prices is in fact an inevitable consequence of chronic resource insufficiencies, whether we’re talking about industrial, energy or agricultural resources. Rather than asking which direction real raw materials prices are going, we must now ask how long it will take to erase the long period of price decline seen between 1980s and the 2000s.

Rise in cycle frequency and magnitude. Given that any sustained period of expansion would be likely to run into an ever increasing number of physical constraints as time goes by, cycle durations are likely to become significantly shorter. However, greater cyclicality doesn’t mean that the cycles will be smoother. On the contrary, in view of the factors underlying the increase in demand, the upward phases of the short cycles are likely to be particularly pronounced, triggering recurrent price swings which could act as an automatic stabiliser. Movements in the price of raw materials and their resistance and support points look likely to play a key role in the cyclical shifts of the period.

Rise in cost of capital and slowdown in productivity gains. For economic intermediaries and the investment community, a series of short cycles spells relative instability and reduced visibility. These characteristics are generally bad news for investment as risk-taking would need to be carried out against a backdrop of potential resource shortages. This observation raises questions over the future development of commodity supply despite the context of increasing demand, given that savings sources are declining due to population aging in wealthy countries and this is likely to lead to a shortage of capital supply and a proportional increase in cost of capital. None of this bodes well for company performance. The slowdown in productivity gains that has been observed in the developed countries for almost a decade now thus looks set to continue and to spread to the newly industrialised countries.

State intervention, regionalisation of trade. The underlying scarcity of resources could pave the way towards a resurgence in regulation, as already observed with the restrictions on the trade of raw materials recently imposed by a number of countries. A rise in tensions on the commodities market and a diminishing supply of capital will considerably increase the temptation for governments to become increasingly involved in the management of resources. While strong inter-dependence reduces the risk of a return to widespread protectionism, a significant shift towards the regionalisation of trade, as opposed to the globalisation seen over the last 20 years, seems highly likely. Given the level of interdependence and tension, developments in global governance will be vital, meaning that a stronger regulatory framework will be adopted in an increasing number of economic and financial domains.

And the two most important take home observations:

Return of inflation

The stage is set for the return of inflation. It is merely a question of time before the global inflationary movement gets underway. The realisation that the emerging countries will account for the bulk of the growth in demand does very little to change this conclusion in a world characterised by a high level of inter-dependence and one that is increasingly being driven by the rising influence of these new players. The fall in competition that has already been triggered by the asymmetric demand shock represents the most efficient catalyst for the proliferation of the global price rises that have already been evidenced by the rapid widespread increase in the international trade prices of manufactured goods.

Widespread increase in interest rates

The growing structural imbalance between supply and demand looks set to trigger a very pronounced rise in interest rates as time goes by. There is also a significant risk that this movement will be accentuated by the structural decline in savings capacities on a global level.

And nor for what everyone has been waiting for: what does this all mean for equity markets. Well, it’s not all that bad…

The rising power of the emerging economies comes at a high collective cost and raises many questions. To say that this picture does not evoke a scenario of harmonious growth would be an understatement. At the same time, neither does it necessarily evoke a depressive scenario.

Firstly, because as a result of these shifts many billions of people will gain access to an unprecedented level of development and revenues. Young countries with substantial natural resources will find themselves with a significant source of growth in a world of scant resources. Alongside the progress already made by Asia, this new environment will represent a powerful development platform for Africa, forming a trend that is already clearly under way.

Secondly, because long-term economic history shows that a certain level of constraint is needed to stimulate the innovation and transformation that has ultimately allowed mankind to progress. While it is clear that the innovation process is currently lagging behind the development of demand, it is the distortions created by this imbalance that should allow crucial progress to get the upper hand.

Finally, because the changes under way in the emerging world offer the developed world, with its aging and over-indebted population, the only true chance it has of avoiding the projected structural decline that it faces without this external impulsion. At the end of a 30-year process that began at the end of the 1970s with the realisation that, only by distributing wealth through the liberalisation of world trade could the global economy thrive in the long term, the circle is now complete and this is obviously welcome. The years of hyper-competition and flagging industrial employment are drawing to a close. While the decline in productivity gains may not bode well for corporate profitability, it nevertheless marks a radical shift in the environment for the employment markets of the developed countries which, combined with the growth opportunities offered by the emerging markets, provides them with a precious if not their sole support for future growth. What is more, the inflation that will accompany this global economic transition represents the only chance these countries have of reducing their enormous debt burdens in the long term.

The financial outlook for the coming years looks set to encounter all sorts of hurdles and sources of volatility, yet it is not irretrievably headed towards depression.

Alas, the sugarcoating quickly ends when one thinks realistically about things:

It is fair to say that shorter economic cycles, rising raw materials prices, the return of inflation and soaring interest rates undermine the medium-term outlook for the equity markets. Such conditions will no doubt cause continued uncertainty which will probably prevent the developed markets from finding their way for still several more years to come.

And the conclusion: the depression that the developed world lived through in the aftermath of Lehman is slowly shifting to the very same dynamo to carried the world across the abyss and has so far continued to push the global econmoy forward tirelessly.

Paradoxically it is the pressure that this new growth regime puts on the long-term performance of the emerging market capital markets that represents the biggest constraint to the development of the capital markets and their relative performance. The emerging markets have barely had time to absorb the changes that are currently taking place and, at this stage of their development, they would be far more vulnerable to problems created by high inflation.

However, if this were the case, then the characteristics of the Kondratien winter that should emerge in the developed world in the aftermath of the financial crisis could give way to a new Kondratief cycle dictated by the developments of the emerging world.

And yes, what look at the future would be complete without the good old Kondratieff cycle chart which sadly predict that we are now entering the last season of it all.

Indeed, winter will be marked by “concern, fear, panic and despair”; when there is virtually no credit following global credit crunch, when rates and vol fall due to a credit crisis, and when the only assets generating returns are gold, cash and bonds. This is the deflationary endgame, and the world’s central banks know it. Throughout history this terminal deflationary threat is what always forces money printing authorities to make their last stand against the end of the cycle, knowing full well the status quo would implode in a singularity of risk off‘ness, unless something is done. And that one something is always, without fail, the rampant printing of money to stave off deflation. Always. Without exception. Just open up a history book. And no. This time is never different.

Full SocGen report here:

When Demand Outstrips Supply – Copy

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Original source at: zero hedge - on a long enough timeline, the survival rate for everyone drops to zero | http://www.zerohedge.com/article/coming-new-world-order-revolution-how-things-will-change-next-20-years-kondratieff-cycle-per

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How to Kill a Dollar 

Courtesy of Phil of Phil’s Stock World 

How do you kill the Dollar?

That’s the question that was on everyone’s mind last week. The smallest indication of Dollar strength caused a Global equity meltdown. As Stock World Weekly has been pointing out all year, and as evidenced by this 2-year chart of the Dow relative to UUP (Dollar index), essentially our entire 40% rally since last summer was at least augmented by QE2’s 20% weakening of Dollar buying power. 

If we give the market the benefit of the doubt and say there should be a 1:1 relationship between the Dollar losing buying power and the price of equities (which are priced in Dollars) rising, then we could assume that 20% of the rise in the market was “natural” while the other 20% was inflated due to the weak Dollar.  BUT – you have to take into account the double boost that is given to commodity companies who get paid more for what they sell. That’s tremendous over- PRICING of the energy, mining and agricultural sectors.  Our exporters also greatly benefited from the strong Dollar and that benefit will reverse itself should the Dollar reassert it’s strength.  (You can review our Billions of Dollars of profitable trade ideas in the Weekly Wrap-Up, many of which will be useful again this week if we keep falling!) 

Obviously, no one is ready for this. The weak Dollar was pretty much the only reason we had the pretense of a global recovery.  It made it look like there was a demand for commodities (there was not), it made it look like there was a demand for American goods (there was not) and it made it look like we were paying our debts, which we were – but with discounted Dollars that were being created by the Federal reserve at a rate of over $50Bn per month.  

In fact, the Fed has expanded its balance sheet (ie. printed money) by $2Tn since October of 2008.  As you can see from the chart on the left (from the Cleveland Fed), there have been huge increases this year in “Long-Term Security Purchase” (T-Bills) as QE2’s primary purpose was to keep our lending rate artificially low by faking a demand for the $140Bn a month of debt paper that is being issued by the Treasury.

This chart just covers the first four months of the year and you can see Long-Term Security Purchases (in Red) grow from $700Bn to $1.3Tn in 5 months of QE2 (beginning in December).  This has not been an issue of the Fed putting training wheels on the bike for us – this is the Fed drugging us, sitting us on the floor, playing a video of a bike ride and pretending we are ready to go on our own.  

Clearly we are not ready at all!  Just the threat of the removal of QE2 has caused the global economy to begin to wobble and we’ve fallen 7.5% in 30 days and we can’t get up.  The Dollar hasn’t actually gone anywhere – it has simply stopped going down.  We spiked to a low of 72.95 at the beginning of May and are now back to the 75 line, that’s up 2.5% from where we called a market top due, in fact, to the Dollar bottom call we made at the same time.  Now we are, hopefully, about halfway through a correction IF they can get the Dollar to stop at the 77.50 line, which is the falling 200 dma.  We discussed this last night in Member Chat so I won’t go back over it, but it’s all very dependent on whether or not we can slow this descent of the Global Markets and stop them from breaking critical technical support (as I mentioned last Tuesday, S&P 1,266 is the single most important line that needs to hold).  

The entire financial sector threw a temper tantrum starting with JPM’s Jaimie Dimon, who whined almost as much as Bernanke as he spun his little tale of banking woe if Uncle Ben should cut off his QE2 money and leave him at the hands of the evil regulators and their “rules” that might stop him and his pals from destroying the Global Economy (again).  That sent XLF down to new lows and the financials are down over 10% since early April. We’re now playing them for a bounce this week in to option expiration day on Friday.  What Dr. Bernanke and Mr. Dimon both seem to forget is we used to regulate banks just fine under the Glass-Steagall, which worked well for almost 70 years until it was repealed and replaced by the Gramm-Leach-Bliley Act that paved the way for a decade of Bankers Gone Wild.  

So here we are, 11 years after Gramm-Leach-Bliley began the destruction of the Global Economy, and what are we going to do about it?  We’ve created a monster and that monster is the heart of our economy – we can’t kill it.  We could have/should have let it die back in 2008 when the whole system was collapsing but, instead of spending $8Tn on unemployment and infrastructure (enough to give 150M US workers $53,333 each!), we gave it to the Banksters so that they could get back on their feet and, hopefully, eventually, trickle down some of their wealth on the rest of us.  

Of course it’s stupid.  It’s also stupid that we have the World’s lowest EFFECTIVE Corporate Tax Rate and that our top 400 households (who average $300M a year in income) pay an average of 16.6% in taxes while the average family earning over $1M a year pays an average of 22.8% in taxes – 33% LESS than families earning $50,000-250,000 a year!  Our ENTIRE deficit is right there – in our lack of collections, not our excess of spending, which is in-line as a percentage of GDP with the rest of the World.    

Keep in mind that the 11.2% per Million ($112,000) that a wealthy family doesn’t pay, represents 11.2% MORE that 10 families earning $100,000 have to pay ($11,200) to balance out the revenues. This does not even take into account regressive taxes like Social Security, Medicare, Sales Taxes and Property Taxes – all of which disproportionately tax the poor as a percentage of their income.  For people with fixed mortgages, rising property taxes are the number one reason families can no longer afford their “mortgage payment“. 

This was a very clever offshoot of the Reagan Revolution, where home ownership was encouraged under the Tax Reform Act of 1986 while, at the same time, the Government “de-centralized” and shoved a huge portion of the tax burden away from the Federal Government (where income is taxed progressively) and down to the Local Level, where regressive taxes were the norm.  Over the past 24 years, this has shifted over $2Tn worth of tax payments from the top 1% to the bottom 90%.

Well, no use crying over spilled middle-class dreams, is there.  What we have now is an economy that is almost entirely driven by Banking Interests so, if we want our markets to be strong, we need to do what is good for the banks.  At the moment, that means keeping the Dollar as weak as possible. All the stops were pulled out this weekend, beginning with Jean-Clade Junker on Saturday, who lashed out at the US – calling our debt levels “disastrous.”  That managed to knock the Dollar down from Friday’s 75.30 level back to the 75 mark in early EU trading and at 9:30 this morning we hear from the Fed’s Fred Lacker and then, at 7 pm, it’s Fred Fisher’s turn to give us an Economic Update.  

On the other side of the pond, Bundesbank’s Jens Weidmann says a Greek default would not destabilize the Euro saying:  “If the commitments are not met, that cancels the basis for further funds from the aid package.  This would be Greece’s decision, and the country then would have to bear the surely dramatic economic consequences of a default. I don’t think this would be sensible, and it would surely put partner countries in a difficult situation. But the euro would even in this case remain stable.”  Weidmann’s depiction of a default as a liveable outcome contrasts with warnings from fellow ECB officials Lorenzo Bini Smaghi and Christian Noyer, as well as European Union Economic and Monetary Affairs Commissioner Olli Rehn, who described it as a “Lehman Brothers catastrophe” last week – causing the Euro to hit new lows for the month.  

Meanwhile, heading a little further East, China’s June CPI will not hit a record high of 5%. According to the China Securities Journal, it is now likely to hit 6%. Meanwhile, our friends at the IBanks have boosted their bullish bets on Agriculture for the third consecutive week. If all goes “well”, maybe we can shove China’s food inflation high enough to push the CPI over 7% in July! It doesn’t do any good to burst the oil bubble if all the money just moves into a food bubble. We made great money betting that just 369,000 oil futures contracts were unsustainable at $101+, now there are 759,974 net long Ag positions. This can get really, really ugly if they can’t find some way to knock the Dollar back down.  

Let’s be careful out there.  

 

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Original source at: zero hedge - on a long enough timeline, the survival rate for everyone drops to zero | http://www.zerohedge.com/article/how-kill-dollar

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