Gold analyst and investment expert Paul Van Eeden defends his view that current high oil prices are all down to the Fed and its loose monetary policy. I can only fully agree, and wish I had taken his advice on buying bullion a year ago when we met in Dubai. Van Eeden is a tough South African intellectual with a no-compromise approach to economic theory and sticks to his guns. He is right on this and right on precious metals, and particularly junior gold stocks which he champions.
May 31, 2008
Van Eeden says high oil price due to Fed policy
Memo to Hank Paulson on his visit to the UAE
US Treasury Secretary Hank Paulson arrives in the UAE today at the start of a tour of the Middle East. He is expected to reassure the government that investments from sovereign wealth funds are welcome and that the US dollar is coming off its lows.
Behind the scenes he could well be battling on two fronts: trying to secure additional oil supplies to keep the price of Black Gold down; and reassuring the government that a revaluation of the dirham is not required as the dollar is recovering.
The problem is that this is a case of the pot calling the kettle black. It is loose US monetary policy that is driving oil price inflation. US interest rates are being held below the level of inflation and this is pushing investment into an asset class that can hold its own against inflation: oil. This is a self-fulfilling investment cycle, and is a market phenomenon that has little to do with supply and demand.
It is the same loose monetary policy that is devaluing the US dollar to save the US financial sector from its bad lending practices, and pressuring the dirham downwards due to the fixed dollar-peg.
Now while it is possible that the US dollar could be short-term over-sold and due for a longer rally than the one seen over the past month, the longer term direction of the US currency is still down, with interest rates held low to support a flagging economy while the European Central Bank fights inflation alone. That will not sustain a dollar rally.
Ex-Goldman Sachs chief Paulson will need all his persuasive charm in the UAE capital to persuade leaders that black is white. The difficulty is that what is not true can not be re-stated as the truth. Fortunately for Paulson he has only another seven months in office and will not be there to be held accountable for what he says today. Heaven help President Obama!
But I suppose Middle East conspiracy theorists will also be working over time on this visit. Perhaps Paulson has a big strategy to get the world economy back on its feet by this autumn and needs the help of Abu Dhabi? The presidential election is a last stand for this generation of Republicans.
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May 30, 2008
Geopolitics, Iran and the price of gold and silver
It gave me no pleasure to read an article in the Gulf News this morning by former German foreign minister Joschka Fisher warning Iran that the US and Israel appear to be gearing up for a strike on its nuclear facilities before the change of US President.
Gulf News is published in Dubai which is a few hundred kilometers from Iran, so it is clear to whom the message is intended to go. The Israelis are apparently emboldened by the success of their strike on Syria recently, and fear the political ‘window of opportunity’ for action will go with George Bush’s exit from the White House.
I am not a political commentator and do not want to get involved in the politics of this matter. But from the standpoint of precious metal investors this is similar to the perfect storm that produced the price spike of 1980.
Then it was the Russian invasion of Afghanistan that scared the world stiff and sent gold and silver prices through the roof; and that was after the Iranian revolution in 1979 which had already destabilized the Middle East, and indeed precipitated the ill-fated Russian invasion.
Herr Fisher is clearly hoping that by stating the danger clearly Iran will behave in a manner appropriate to avoiding such a strike and its uncertain consequences for the region. It is not as though the Middle East is unused to living under the shadow of possible military adventures, and has avoided many such scenarios in the past.
However, this is another reminder of the role of gold and silver as safe haven assets in times of geopolitical uncertainty. Expect to see the price of precious metals rise significantly if tensions in the Middle East mount again, and there will be a sudden spike if anything actually happens.
May 29, 2008
Entering phase two of the credit crunch, buy gold and silver
The real credit losses for global banks may just be starting as defaults emerge on credit cards, car loans and corporate loans. This will be the stage two of the global credit crunch as markets move out of the eye of the storm and back into crisis mode.
As The Daily Telegraph reports today ‘the cost of insuring against default on the bonds of Lehman Brothers, Merrill Lynch and other big banks and brokerages has surged over the last two weeks, threatening to reach the stress levels seen before the Bear Stearns debacle. Spreads on inter-bank Libor and Euribor rates in Europe are back near record levels.’
The increase in the cost of borrowing is what the Fed thought it had solved back in March but this seems to have been a false dawn. There are even worries that the Fed itself is running low on credit with $300 billion swapped for dodgy mortgage debt and $130 billion put up for Term Auction Credit.
Indeed, as this Blog cautioned a few weeks ago the capital markets have been passing through the eye of the storm. This is a period of false calm before the real consequences of recent events become apparent.
Corporate bankruptcies are a later cycle phenomenon and naturally try to remain hidden until the last moment. For likely candidates look to the oil-price hit airlines or financial institutions with perilously weak balance sheets or property developers hit by falling prices.
The problem is that panic is the natural response by capital markets to such events. The question is then who comes next? What are equities really worth if profits are falling? How low can share prices go?
For anybody who still insists on holding US equities in this financial crisis how much more of a warning to sell do you need? Buy precious metals for a safe haven.
Revaluation urgently needed in the Gulf States
Inflation levels have picked up again across the GCC this year. We have Saudi Arabia officially in double-digits for the first time. In the UAE the dampening of rental inflation by new supply has not happened; apartments are fetching 20 per cent more in rent than a year ago in Dubai and the Colliers International survey of Abu Dhabi pointed to a 22 per cent increase in rents and 53 per cent increase in house prices.
Speculation about a possible revaluation of Gulf currencies reached a peak before a meeting of heads of state at the end of last year. Since then clear statements emphasizing the commitment to the dollar-peg and current exchange rate levels have been issued. But the hyper-inflation that economists flagged up has arrived, and the promised recovery of the US dollar has not. Is it time to think again on revaluation?
Six months ago it seemed reasonable to argue that imminent new supply in Dubai – such as the Jumeirah Beach Residence and Jumeirah Lake Towers in New Dubai – would bring rental inflation under control. But the demand for property in booming Dubai has proven so strong that this forecast has been shown to be incorrect and the inflationary spiral in prices is clear.
It is the same story in neighboring Qatar, which actually has the highest inflation rates of the GCC. Food prices are another critical area. Governments are imposing price controls on basic products but the prices of every other kind of food product are spiraling higher. It is just not possible to regulate every last cornflake, and if retail margins are squeezed too tight then this risks creating shortages of the most basic products.
At best price controls are a temporary solution to inflation, at worst they interfere in the operation of a free market and create more problems than they solve. Rent caps are similar. They work in the short-term but in a region like the GCC with its high turnover of expatriate staff there is only ever a short delay before landlords can apply the market rent. Meanwhile, people find themselves unable to move apartment because new rents are impossibly high and when their current rental period expires they may have to go home.
Inflation is also distorting fuel costs. Diesel in Dubai costs double what it does in neighboring Abu Dhabi because the latter has its own refinery and can subsidize costs. A bag of fertilizer for the garden is now Dhs240 whereas a month ago it cost Dhs100. It really is amazing how in such a short time – no more than a year or two at most – inflation can produce market distortions even in an economy as open to free trade as the Emirates.
The big hope at the start of the year for policymakers was that the US dollar would bottom out and begin to recover. For let us not forget that it is the weakness of the US dollar that has made import prices rise for many goods in the Gulf States. Oil is priced in dollars. But the majority of imports is from Europe and therefore cost more if the dollar devalues.
It was always open to some debate as to whether the dollar would recover. Certainly the further interest rate cuts by the Federal Reserve this year have done nothing to strengthen the greenback. Interest rates are now at two per cent and the question is whether they will go lower. Optimists say that the rate cuts are over and just as soon as the US economy shows signs of recovery then rates will actually go up.
But this is nonsense. US house prices are falling and even optimists reckon that they will not bottom out until the middle of next year. How can the Fed raise rates in that environment? Indeed, is it not more likely that US equities will increasingly look overvalued with corporate profits likely to disappoint this year, and if the stock market tumbles then the Fed may well cut rates again. They could go to one per cent or even zero.
That will leave the Gulf States with hyper-inflation and an even more wholly inappropriate interest rate regime. The inflation levels we see today will worsen considerably and real estate will boom to astonishing prices. Even the US Treasury appears to be conceding that the US dollar peg is looking an increasingly untenable policy option for the Gulf States.
The latest US Treasury report to Congress on International Exchange Rate Policies recognizes the inflationary pressures that the dollar-peg is putting on the Gulf States which Merrill Lynch says is a green light for revaluation. This is a highly significant report because it is widely believed that US opposition to revaluation is the one reason that it has not happened this year.
‘The US recognizes significant appreciation pressures on the GCC countries,’ says Merrill Lynch. ‘From a fundamental standpoint we believe the US authorities have hinted that there is a need for more exchange rate flexibility.’ Merrill Lynch predicts a move to a currency basket within the next few months and a five per cent appreciation in Gulf currencies before the end of the year.
Certainly from any commonsense standpoint the maintenance of the current exchange rate regime stands ultimately to damage Gulf economic interests by producing a boom-to-bust economic cycle of significant proportions. And almost anybody who has studied economics will draw the same conclusion. This is text book economics not scare mongering.
For very high inflation levels distort investment into real estate and financial services, starving other sectors of resources, and then inflate prices to levels that are unsupportable in even the most minor setback. Preemptive action by Gulf central bankers to keep this economic boom under some kind of control through revaluation and currency reform is therefore something which should be considered before it is too late.
If even the US Treasury realizes that the status quo has to change then this ought to be a green light to GCC policymakers to find a face-saving compromise. It might be that the peg is kept until the planned currency union in 2010 but a coordinated series of revaluations is phased before then. That will not be an easy policy to pursue but then is it not better than the alternative?
May 28, 2008
Buyers queuing overnight as demand booms for Dubai real estate
Negative real interest rates courtesy of a dollar-peg, high oil prices, not a little media attention and still attractive price levels are keeping Dubai real estate booming. It is a total contrast to most global property markets where activity has slowed or is in recession.
New project launches in the right locations sell out quickly. Yesterday Deyaar Developments announced the sell-out of its Mirar Residences, one of three towers in the DuBiotech business park, despite the recent arrest of its top management team for alleged embezzlement.
Not all buyers are so lucky. The National reported this week that ‘hundreds of potential buyers, some of whom had specially flown into the country, were turned away by Nakheel yesterday after the waterfront property they were after sold out.
’Overwhelming interest in Nakheel’s Badrah waterfront developments led to the cancellation of about 400 appointments with potential buyers. Badrah is a district with 45,000 homes, and Nakheel sold about 1,000 apartments on Sunday, the first day of a planned two-day sale, an official said. Another 60 apartments left over from Sunday were released to some customers yesterday, but the remaining hundreds of potential buyers missed out.’
There is indeed considerable competition to buy in favorable locations. Even the 10-kilometre desert hotel strip project Bawadi had people queuing for 14 hours by buy homes in its joint venture with Emaar Properties. The lucky 120 slept overnight to keep their places in the queue, and disappointed people were told to come back for the next phase of sales.
This is almost nostalgic for an early buyer of Dubai property like myself! Five years ago I was one of the thousand buyers who queued at the Godolphin Ballroom at the Emirates Towers to buy a villa in The Meadows. We thought it was madness but property prices have quadrupled since then.
But Dubai property prices remain 25 per cent cheaper than a London suburb with take-home pay levels rather higher and a great many bankers looking to relocate here in the near future. Personally I think prices have higher to go as completed property is in very short supply, and there is plenty of demand to soak up new real estate completions for another year or two.
No boom last forever, but this one is getting hotter this summer! I can’t see the heat subsiding at least until the Burj Dubai, the world’s tallest building is topped out next summer. The illustration above compares this awesome skyscraper to the holder of the tallest building title in Taipei.
May 27, 2008
New Hunt brothers of the silver market most likely to live in Arabia
Beginning in 1973 the then richest family in America decided to beat inflation by buying silver, then $1.95 an ounce. It worked brilliantly and by 1979 the Hunt brothers had amassed half the world’s silver in a pool with wealthy Arab investors and the price peaked at $54. But they used too much leverage and the authorities changed the rules to pop the silver bubble. Could this happen again today?
As inflation rears its ugly head there are bound to be very wealthy people like the Hunts who look for a way to protect their assets. Indeed, Warren Buffett, George Soros and Bill Gates are among individuals known to have invested in silver.
But so far nobody has gone as long on silver, or invested as publicly as the Hunt brothers in the 1970s. That perhaps was one of the mistakes that the Hunts made, although it must be difficult not to attract publicity if you are effectively cornering a market, something the Hunts still deny.
Why did the Hunts pick on the silver market? Then as now hard assets provided a hedge against surging inflation: the supply of silver is basically finite while the paper money supply is infinite. So in a time of inflation precious metals make sense for investors looking to preserve real value and are monetized.
The Hunt family clearly did not originally make its billions without a shrewd investment gene in its pool. And choosing silver was a leveraged play on the much larger gold market which is also an inflation hedge. Basically the silver market is around one hundredth of the size of the gold market so it is possible for a very large player to dominate that the silver market to its advantage.
Even the richest private individuals or oil sheikhs would fail to control the gold market which is simply too large. Silver is another matter, and actually 28 years post-Hunt nothing much has changed. Silver is still a tight market where a surge in investment demand could produce violent price changes.
But it says something about the silver market collapse that the Hunt’s precipitated – when central banks pulled the rug from under their margin trading – that silver is trading today at around $18 an ounce, still down on its $54 peak almost three decades ago. Confidence has still to rebound and investor demand for silver is a tiny fraction of the demand for gold, although it is growing strongly.
I do not think we will see another cornering of the silver market. But the inflation protection story that originally caused the Hunts to invest in silver in 1973 is another matter entirely. Silver has moved up in the 2000s alongside gold.
But the silver-to-gold ratio has a long-term average of 15 and not 52 as it stands today, and that price gap should now close, along with the gold-to-oil ratio. Bring silver back to its long-term average ratio to the gold price, and restore gold to its long-term ratio to the oil price, and silver will be five times higher in value – with no further increase in the oil or gold price.
Yet if the Hunt saga offers a single lesson it is to avoid margin trading in precious metals. For one thing price movements can be far too volatile to make this worthwhile, for another it leaves you vulnerable to lenders. And just remember that the Hunts would have been brilliantly hedged against inflation if they had not got greedy and borrowed too much. That was their real error, ignoring the central banks which spiked the silver bubble by cutting off credit.
It could be that the next Hunts are rich families living in Arabia who decide to buy silver as a protection against rising global inflation. Petrodollars have historically found their way into precious metals and after all, the Hunts’ co-investors were Arabs and history does have a habit of repeating itself.
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Dubai Q1 export trade booms by 79%, cashing in on oil prices
Dubai is feeling the searing heat of the oil boom in the Middle East with exports rocketing by 79 per cent in the first quarter, and total non-oil trade in the region’s commercial hub city up by 46 per cent to $58billion.
This is a fantastic performance by any yardstick. Note that these figures exclude oil earnings which will have been more than $10 billion in Q1 thanks to surging oil prices.
The statistics are compiled by Dubai World, which runs the ports and free zones of Dubai and show direct non-oil trade – excluding free zones and customs warehouses grew from $25 billion to $39 billion.
Dubai World chairman Sultan bin Sulayem said: ‘The growth is fuelled by the government’s relentless efforts to upgrade the existing modern infrastructure of ports, airports and land transportation networks connecting Dubai to the world.’
He also noted that high oil prices are stimulating increased public spending in the region, while locally the ‘unprecedented construction boom and commercial development are factors that contributed to this growth.’
This is certainly a bold set of statistics to quote to anybody who thinks the Dubai boom lacks substance. Dubai has always been a trading centre and this continues to be the backbone of its economy. And in the midst of the biggest oil boom in a generation Dubai is profiting handsomely from its past investment in infrastructure.
Other cities might wish that they had done the same now. But plans are no substitute for completed infrastructure to service and profit from the boom.
May 26, 2008
S&P reckons oil market not like the 70s but good for gold
Today I caught up with Standard & Poor’s VP for commodities, Eric W, Kolts who was over from New York speaking at a conference in Dubai. He is resolutely bullish on oil prices, and rejected my comparison to the 70s.
‘I can remember what happened then personally and it was not the same. The 70s oil price spikes, and there were two big ones were caused by political interference in the marketplace, not the fundamentals of supply and demand.’
Mr. Kolts is of the opinion that the oil market has undergone a structural shift with demand way out of line with the capacity of existing installed infrastructure to deliver supply. This is very different from political interference – the Arab oil embargo of 1973 or the Iranian revolution in 1979 – and makes a correction in price far more difficult.
‘We have seen forward oil prices move up by an unprecedented $45 since the beginning of the year,’ he says. ‘Of course there is a speculative element but this is also the start of including the cost of new infrastructure in the oil price. It is a structural shift and if you are going to tap oil offshore in a place like Brazil this is necessary to pay the cost of extraction.’
On the demand side Mr. Kolts is convinced that the tripling of the GDP of China and India since the year 2000 has also produced a permanent increase in demand for oil as China’s one million new car owners a year are not about to go back to their bicycles. Yet the oil market is still puzzling.
‘We have seen the open position in WTI crude declining since July 2007 which implies short position covering and should be producing a decline in the price,’ he says. ‘But it looks as if over-the-counter trading is more than compensating with prices rising further out.
‘I think oil prices will prove far more resilient in this climate and that we are in a super bull market due to the long-term fundamentals of emerging markets which have now emerged.’
At the same time Mr. Kolts believes petrodollars will find their way into gold as a dollar hedge with silver ‘riding on the coat-tails’ of gold. ‘The Middle East and Russia were always the big buyers of precious metals when I was a trader in the 1980s and this is of course a hedge against inflation and a declining dollar.’
But clearly S&P’s top commodities analyst does not see the oil boom fading away anytime soon because of market fundamentals. ‘That would take a very deep and long US recession,’ he concludes. Interestingly Mr. Kolts is very bearish on the outlook for US equities.
US Treasury green light for Gulf currency revaluation
The latest US Treasury report to Congress on International Exchange Rate Policies recognizes the inflationary pressures that the dollar-peg is putting on the Gulf States which some analysts see as a green light for revaluation in the oil-rich region.
This is a highly significant report because it is widely believed that US opposition to revaluation is the only reason that it has not happened this year. Gulf countries are all running double-digit inflation, and wholly inappropriate low interest rate regimes due to the dollar-peg.
‘The US recognizes significant appreciation pressures on the GCC countries,’ said Merrill Lynch. ‘From a fundamental standpoint we believe the US authorities have hinted that there is a need for more exchange rate flexibility.’
Merrill Lynch predicts a move to a currency basket within the next few months and a five per cent appreciation in Gulf currencies before the end of the year.
But this would not be the first time that Merrill Lynch has been overoptimistic and premature in its forecasts on revaluation. Recent statements from Gulf central bankers have declared trenchant support for the existing exchange rate regime, although who makes the real decisions on such matters of vital national importance is a matter of conjecture.
But perhaps Merrill is right to conclude: ‘This represents a modest change in focus but we believe it a big signal for the currencies of the GCC.’
Certainly from any commonsense standpoint the maintenance of the current exchange rate regime stands ultimately to damage Gulf economic interests by producing a boom-to-bust economic cycle of significant proportions. And almost anybody who has studied economics will draw the same conclusion.
For very high inflation levels distort investment into real estate and financial services, starving other sectors of resources, and then inflate prices to levels that are unsupportable in even the most minor setback. Then follows the crash!
Preemptive action by Gulf central bankers to keep this economic boom under some kind of control through revaluation and currency reform is therefore something most economists would welcome.
