“The [China miracle] story is getting harder and harder to believe”

… said Jim Chanos on CNBC in September 2009:

“You have to keep in mind that the last command economy that really saw this kind of growth was the old Soviet Union and what happened was the misallocations of resources into inefficient plants, dams that burst, nuclear plants that had accidents and so on and so forth. China is heading the same way.”

He is not the only one. There is now a growing group of market observer (including Michael Pettis, Pivot Capital or Hugh Hendry from Eclecta AM), who are increasingly worried about the state of the Chinese economy. As Jim Chanos said about Enron, it is a “trust me story”. There is no reason to take for granted the numbers published, as it is almost impossible to verify them. Also, even if they were compiled and published with the best intentions, it would be naive take them at face value. China is having enormous difficulties collecting accurate data.

Additionally, most of them are inconsistent. Car sales jumped 94.7% in August, yep gasoline sales rose by just 6.4%. According to Gordon Chang, “There are reports that central government officials have ordered state enterprises to buy fleets of vehicles and that these businesses are storing them in parking lots across the country”.

“Beijing’s statisticians have gone back to their old tactic of making up figures to support the Politiburo’s predictions”, he continued. In the end, China probably publish what it wants, statistics being highly political.

On last point that resonated with, it is Jim’s comment about “command economies”. None of the previous experiences have been successful. As much as regulation is necessary to avoid a “wild wild west” type of economy, market signals are necessary to allocate resources properly. It won’t avoid mistakes, but so far it is the best system we know. Decentralized decisions are way more efficient that central planning. States can help, support and should regulate, but can not replace rational and informed local decisions. It had always lead to significant misallocation of capital and, even if there is a very small chance the Chinese central government is making enlightened decisions, the probability is very low, and should not be taken for granted.

As much as I am a long-term optimist about the Chinese economy, I think the next few year could be brutal. It is always difficult to change growth pattern, and so far not much has been done to reverse the major imbalances.

Jim Chanos on China (Transcript)

“China has embarked on a capital-spending bubble the likes of which the world has never seen. Buildings are going up with no tenants, roads are built with no traffic, shopping centers are built with no tenants or customers, yet they continue to be built and they continue to be planned.”

“China is Dubai times 1,000, if not a million. At some point, all of this (ill-advised) investment will come home to roost.”

Jim Chanos’ opinions are usually very prescient. So when I read his opinion on the state of the Chinese economy, I was interested in finding more. I found an interview of him on CNBC (from last month), and tried to write down its transcript:

“I think the story is getting harder and harder to believe”

“And I’m not the only guy crying about the data coming out of China. You are seeing a lot more articles being written about it, a lot more skeptical voices being heard about just how accurate some of this data showing this Chinese miracle. And the fact of the matter is I don’t think it’s very accurate at all.”

“You have to keep in mind that the last command economy that really saw this kind of growth was the old Soviet Union and what happened was the misallocations of resources into inefficient plants, dams that burst, nuclear plants that had accidents and so on and so forth. China is heading the same way.”

“We see increasing sign of investment in production facilities that immediately are idled, buildings that are crumbling.”

“There seems to be a wholesales fudge factor, which is all well and good, but if you are making decisions based on those numbers, if global investors are making investment decisions on those numbers, you got a problem.”

In the end, GDP growth does not mean wealth creation. Take the example of a crumbling bridge that is rebuilt every five years, the process creates GDP, but not add wealth. This is the risk of “construction based economies, like the old Soviet Unions, like China today” he added.

China’s empty building, and cities (Video)

Two interesting videos of empty buildings, or even empty cities, in China. The first story is from Al Jazeera’s Melissa Chan, reporting from Inner Mongolia, where a whole town built with government money is standing empty.

I especially like the quote from Patrick Chovanec, professor at Tsinghua University, talking about investors buying empty homes, in an empty city…:

“Nobody ever really lost money in real estate in China, not on a consistent basis, and so people look at that as a very safe investment, and in fact they don’t look at it as a place to live anymore, they look at it as a place where they can put their cash”.

(You can skip the first minute)

The second is a short video from hedge fund manager Hugh Hendry (from Eclectica AM), shot early 2009:

The world according to the US

Totally unrelated, but I love it. I hope no one will get offended:

“Risk is on”

While most asset classes are a few percents off their recent highs, it is interesting to note that risk aversion is back to pre-crisis levels. The VIX for example, is now trading around 20, a low level by any historical measure (although it reached 10 in 2006):

Natixis risk perseption index is also back to historical lows:

So while risk persception is at the lowest level it has been in a few years, it is interesting to note that most asset classes are struggling to make new highs. WTI, Eur, S&P are all a few percents off, and have been trading a range for a while. November soon off the table, it is (according to most analysts) time for the year end rally to lift all boats.

Unless this trade is overcrowded… Which could be the case; at the same time operators start to secure their year end bonuses, taking some chips of the table. So the next few weeks could interesting, giving us a clue weither or not we made a intermediary top.

Natixis on “Moving bubbles”

Natixis recently published an interesting paper on a new type of rapidly moving bubbles. (Unfortunately I can’t find it anymore). But the main idea is that the world liquidity is now growing at a faster rate than before the crisis, while the world has already large excess capacities (in production, real estate, …). As a consequence money is not invested into additional capacity, but into existing assets. At the same time risk aversion is retreating.

So this combination of high liquidity, reduced investment base and low risk aversion is going to create bubbles, which will move from asset to assets, as valuations get rich and momentum wane.

In the first phase, liquidity was in going into US treasuries (recycling of commercial balances) and emerging markets. But as prices increased significantly, valuations got less attractive. At the same time some countries, worried by the inflow of speculative money, are raising taxes for foreign investors (like in Brazil for example).

So in a second phase, liquidity could push commodities higher, acting as an investment proxy. [This has probably already happened as commodity prices, as well as commodity related equities and currencies have already enjoyed very large gains]. Until momentum wane.

According to Natixis, the third step could be for the liquidity to flow into American and European equities, “for the wrong reasons”.

While I like the concept of “moving bubbles”, I have some trouble imagining that both European and American equities enjoying bubble style valuations any time soon; even as a consequence of a high level of liquidity looking for homes. It is more likely that we will see high prices volatility around emerging markets, commodities and commodities related equities and currencies, with some kind of long term trend moving higher. At least until the Chinese miracle is debunked (cf. a later note).

Are commodities expensive… yet?

All prices are relative. In this regard, David Rosenberg published an interesting graph, showing the prices of the Commodity Research Bureau (CRB) index divided by the S&P 500:

So even after their large rally, commodities are still very cheap compared to major stock indexes. Incredible amount of wealth have been created, and for years commodity producers have only received a very small portion of it. This portion will probably increase over time, as demand for commodities increase significantly, and economies adjust to higher prices.

World economies can afford higher – much higher – prices. It will take adjustments of course, but it is doable. At US$30 a barrel of oil for example, most people use to think the world economy would crash. At that time the OPEC target price was between $22 and $28 per barrel. Recovering from a severe recession, oil is now above $70 per barrel, and we have adjusted.

The Core Saudi production region…

… covers only 17,140 square miles and would fit into a corner of Utah (source: Twilight in the Desert, by Matt. Simmons, page 119):

I don’t know about you, but I always assumed the Saudi producing area was much bigger…

US Nominal GDP in Gold term

In its latest GBD report, Marc Faber used Gold as deflator of the nominal US GDP, effectively creating an index tracking the US GDP in gold term.

As we can see below, the results are pretty interesting:

The GDP / gold ratio is moving in long term waves or trends, which coincide pretty well with real economic growth (uptrends) and nominal growth (downtrends).

As an aside I also looking at the GDP/gold ratio versus the US unemployment rate:

It is not perfect, but high GDP / gold ratio tends to coincide with low unemployment rate.  It seems to make sense as high unemployment also means low GDP growth, high federal deficit and low interest rate… which can be seens as a good combination for gold.

Another divergence

Since the beginning of this rally, economic surprises and asset prices were moving in tandem, meaning that good “surprises” were lifting prices. Since late October, economic surprises have been mostly negative, but most asset prices have continued to rally.

As an example, here is the Citigroup economic surprise index versus S&P 500:

and versus the CRB index:

It is interesting to see that the nature of this rally is changing, now totally disregarding bad news. Could it be a sign that we are entering into the last leg of this rally, ie. the melt-up phase?