Today In Silver

NOTE: Although written about a month ago for Metal Augmentor subscribers (published on November 17, 2009 at 2.17 A.M. EST), the following is arguably even more relevant today.

Brent Cook wrote an excellent article last week, Pig Farmers are Making Brent Nervous. This is a must read and in many ways reinforces the themes we’ve discussed here for several months now with respect to the speculative nature of the current rally in commodities, base metals and precious metals. What makes us nervous more than the excellent points made by Brent Cook is that he seems to be one of the few to lend a voice to what is so obviously a disaster in the making.

Yes, we’ve read the story before that Chinese pig farmers are speculating in copper but we weren’t aware that Chinese goose farmers are speculating in aluminum! In other words, there is quite a bit of this story that has received almost no coverage yet it seems to explain much better the mentality that is currently driving the gold market than the idea of imminent hyperinflation or the “dollar carry trade”.

Considering Brent Cook’s excellent synopsis of a recent Chinese television special on home-grown speculation, why is a “dollar carry trade” the only possible explanation for the forth that has built into many asset prices? In particular, please pay attention to the following excerpt:

• Because the interest rate is too low in China. Many farmers could make hundreds of RMB profits per tonne, with dozens of Rmb per tonne cost of interests. They use their existing inventories to borrow more from banks. Banks are very ‘happy’ to lend to them. [a side bar here: China’s 4 trillion stimulus package equals about 15% of GDP and according to the Financial Times, bank loans are up ~140% this year to ~8.6 trillion Yuan and official State investment accounts for 88% of GDP growth.  What we are witnessing is Chinese savers experiencing negative real interest rates in their savings accounts: much worse than in the US. At the same time they are able, in fact motivated, to borrow money at rates that are less than the inflation rate. Hence, the massive government stimulus combined with unlimited cheap money has fueled a soaring stock market, real estate prices, and as presented here, commodity speculation.  Approximately 60% of the stimulus money is estimated to have gone into these speculative sectors.]
  
• On the other hand, many stock brokerage firms in China have become futures trading companies this year. Stock brokerage firms are very rich of cash. Private investors plus those brokers have at least invested Rmb20-30 bn in metal futures market. In 2008, only 50 bn Rmb were in the Shanghai futures market. This year, the number has increased to 80 bn Rmb. Everyday, he said, there are more money flowing into the market.

Can you imagine if Citibank or Bank of America were to lend money to Iowa pig farmers so they can stock up on reels of copper wire? Heck, the banks here won’t even lend so the pig farmers can buy feed for their pigs! CIT Financial could not get a measly $3 billion from the banks to essentially save a large swath of Main Street (many small U.S. businesses rely on accounts receivable financing to manufacture goods or maintain inventory). And yet if we are to believe all the blowhards and pundits on the Internet, in the media and in Washington DC, it’s the U.S. banks that are still being reckless with their “dollar carry trades” and other imagined dastardly acts.

We’re not sure how the number was derived, but even if much less than “60% of the [Chinese] stimulus money is estimated to have gone into these speculative sectors”, that would represent a huge red flag and a high likelihood of disaster when the stimulus is withdrawn.

Although we are always collecting new data points, we were already convinced several months ago that China would be the source of the next global financial crisis. Our thesis still exists mostly in the form of a sequence of intangibles in our own minds, but Brent Cook has helped bring our thinking into more precise focus and perhaps even a distillable form. The bottom line is that if you insist on casting your investment lot with pig farmers or the hedge fund manager dolts that Brent Cook describes in his article, that is your choice and your money. For our own part, we will continue to assess the risks and rewards of metal investing with as much cold-hearted indifference as we can muster.

silverax Windbag Wisdom