Sell China and Buy Goldman Sachs


Here’s an interesting pair trade to begin your day with: sell China and buy Goldman Sachs. Okay, okay. It sounds ludicrous. But let’s consider some facts.

Both the S&P 500 and the Dow Jones Industrials closed up about 2.5% overnight. Analysts upgraded estimates for Goldman’s earnings. That sparked a buying frenzy in bank and financial stocks, which took markets higher. Presto, change-o, everything is bull again.

Or is it? We’d suggest that whatever Goldman did to goose earnings is probably not going to be possible for the rest of corporate America. However, that doesn’t mean the pair trade doesn’t have legs. In fact, have a look at the chart below and you might be convinced it’s time to buy the S&P!

Shanghai vs. New York: CSI 300 Index vs. S&P 500, year-to-date.

Thanks to massive stimulus from China beginning in November, there’s been an explosion in consumer and business lending. That’s translated, we’d suggest, into asset inflation. Exhibit “A” is the nearly 75% year-to-date climb in Shanghai’s benchmark CSI 300 index. It has, as you can see, trounced the return in U.S. stocks.

Now there’s more than one way to interpret this chart (this is what makes charts so intriguing but frustrating.) Is this the market’s verdict on U.S. growth prospects and Obama’s trillion dollar deficit plans? Is it vindication that China’s stimulus has been a lot more successful and promoting real economic growth than the $787 billion pile of junk passed by the U.S. Congress?

Or how about a third theory? Is it evidence that China is in the accelerating phase of its own massive credit bubble? And could the collapse of this credit bubble lead to a Chinese Day of Reckoning?

If that’s the case, then it would be time to sell commodities and buy Goldman, or at least time to sell commodities. A collapsing Chinese credit bubble would remove a lot of the demand and price support for Australian commodities (especially coking coal and iron ore). We covered the story while filling in for Kris Sayce at Money Morning today. You can read the whole story over

While we’re on the subject of stimuli, a New York Times story from yesterday suggest that government capital injections and loan guarantees, along with new equity offerings, have allowed banks to evade the inevitable consequences of the popped credit bubble. But the evasion is like hiding under the bed from the bogeyman. He’s still going to get you. Sucking your thumb and pretending otherwise won’t help.

“The capital provided by the government through TARP, etc. has allowed the banks to continue holding deteriorated assets at values far in excess of their true market value,” says Daniel Alpert of Westwood Capital in a note to clients, according to the Times. “It is unrealistic to believe that home or commercial real estate values are destined to recover any meaningful portion of bubble-era pricing.”

This means all the new equity raised by banks after the stress-tests has merely papered over capital adequacy and solvency issues for now. The banks have simply refused to revalue loans on their books and continue to carry them at unrealistically high valuations. If they sold them, they’d got a lot less for them, forcing them to raise more capital (or wiping out their capital and revealing them to be insolvent). Yet many banks are under the absurd illusion that if they hold certain assets to maturity, they won’t suffer any losses.

This is the same as saying million of Americans are going to make their mortgage payments as they lose their jobs and find themselves underwater and unable to refinance. The default and foreclosure data coming out of the U.S. housing market suggest the banks are kidding themselves, or misleading shareholders, or both!

It’s the sort of calculated mis-truth that can cause a short-term crisis to last years and years. The correction is postponed through phoney accounting. It leads to a Ushinwareta Junene, or a lost decade, as the Japanese say. We prefer the Zombie metaphor-an economy full of living dead loans that threaten to infect the real live survivors.

In a ten (or even 17 year period like that) you get low growth, high unemployment, and stock market benchmarks that do not keep up with inflation. Stocks as an asset class perform poorly. Bonds, on the other hand, might go through rallies and corrections and be more tradeable (or rally on deflation concerns, as Marc Faber pointed out late last week).

But whatever happens in ten years from now, it’s pretty clear that the “doing something is better than doing nothing” mantra of Keynesian intervention is a big fat deficit-adding failure. Unemployment is rising. The economy is not fundamentally better off. And bank balance sheets retain a whiff of unreality. More spending cannot be the answer when too much credit was the problem.

-Phillip J. Anderson is one of our panellists at the upcoming “Australia in the Red” summit in Melbourne on Friday, July 21st at the State Library of Victoria. In his book “The Secret Life of Real Estate,” he explains a 17-year cycle in property prices related to land values.

Fortunately for Aussies, the cycle heads mostly up. Not so fortunately, there are periods in the cycle where it corrects and falls in real terms. If you buy near the top and prior to a four-year period of decline, it can be bad for your financial plans.

We’re not sure why, but this idea that cycles run in 17 or 18 year periods keeps cropping up. Last week on CNBC, Art Cashin made exactly the same point. He pointed out that from 1966 to 1982, the Dow Jones traded in a range.

If you began investing in 1966, you didn’t make much money for the better part of two decades. On the other hand, the 1982 to 2000 cycle witnessed one of the greatest bull markets of all time in stocks. Get your timing right and get in the right asset class and cycles do your work for you. Or so it would seem.

Our sense is that right you have a lot of competing cycles. You have a historic low in interest rates across the globe. That led to a period when the cost of capital was incredibly cheap. This kick started an industrialised production boom in the developing world which has a momentum of its own. But is it sustainable?

You also have demographic and psychological and simple life cycles. As affluent Western investors get older, they seek to cash in on accumulated gains and enter into a golden retirement. Where will the money to move markets higher come from? An increase in mandatory superannuation contributions?

We’ll leave you today with a nearly incomprehensible chart that shows an even more intriguing longer-term cycle. The char appears to show that global energy production per capita has peaked and is headed for permanent decline…in other words…industrial civilisation has a lifespan of around 100 years…and we have reached that life span.

Olduvai Theory and the End of Industrialisation

That would seem like bad news. Of course, perhaps post industrial civilisation will be a more pleasant place, albeit with fewer calories and no climate control. In all seriousness, though, if there is any truth to the idea that energy production per capita has peaked, it means China has picked a very bad time to have an energy-intensive industrial revolution. And to the extent Australia is now dependent on China for its prosperity, well the consequences are self-evident.

If the Credit Depression coincides with the Energy Depression, then you’d want to consider a very different financial survival strategy. More on that tomorrow.

Dan Denning
for The Daily Reckoning Australia

Dan Denning
Dan Denning examines the geopolitical and economic events that can affect your investments domestically. He raises the questions you need to answer, in order to survive financially in these turbulent times.


  1. Commodity bubbles – now we are talking!

  2. PS – note there are 2 Richo’s on this site – I’m the one who likes commodity bubbles, going long on the USD and shorting gold – I will rename myself “Richo the 2nd” to avoid confusion with my other “Richo” colleague.

  3. One storey I am definitely not buying is peak energy – The world has coal = The world has energy. The world has Uranium = The world has energy … etc. Or at least the countries that are willing to use them do. Is it conceivable that some technolgy could come along that makes coal “green”? I have no idea. But I at least suspect it is not inconceivable.

    But either way, does anyone really think the world is going to stop using its available energy even if it is dirty? Especially when governments seem as if they just could be getting some sort of global agreement on how they can collect lots of revenue by taxing it. When it would seem that some recent extraordinary government expenditures mean they will be looking for every tax dollar they can get.

    Peak energy does not form part of the equation. Although peak taxation of it very well may.

  4. “We’re not sure why, but this idea that cycles run in 17 or 18 year periods keeps cropping up”

    Isn’t this from Adam Hamilton (Zeal Intellignece) the Long Valuation Wave Theory?

  5. Goldman goosed earnings with index trades. Only the earnings season in equities or physical inventories can stop them. Timmy has seen that they are more dominant than ever and they can take their chosen club of bit players along with them for the ride and agree to ramp each others assets.

  6. Yeah for my AGS energy & gold hold which I have mentioned around here from time to time.

    Peter Garrett of course stuffed up the timing of his 4 Mile go ahead announcement with a trading halt coming an hour or two AFTER the announcement was made.

    Coffee Addict
    July 14, 2009
  7. Short commodities and stock indicies for now in my opinion. Of course nobody should ever short gold though….ever:). I’m just wondering how long it will be though until the next round of inflation rumours/fears take hold once again superceding the current deflation scenario…maybe 4 to 8 months.
    Id love to know what is happening in China…on the street. Surely the cost of living/inflation must be starting to surge.
    Here at home the cost of living is surely on the rise….as always (food,energy etc), although property and the S@P200 are obviously not tagging along.
    Heres a pro-property thought break my norm (bearish). I wonder if its possible to view the FHBG’s of the last ten years (in Aus) as a kind of pre-emptive bank bailout. If so is it not possible that our current government in particular may not seek to up the anti on this (despite signalling the opposite) as deflationary fears increase. Its maybe at least a possibility since it is so widely feared that inflationistas’ in the US will put the money printing pedal to the floor for the same reason (at some future date). Also, there has been a lot of critisism of the cash splashes while FHBG’s seem (at least to me) to be more palatable to the general public. Maybe people are more likley to think they deserve a chance at owning their own home than to think that they deserve consistant cash handouts.
    Whatever the case I will be waiting for a confirmed top in property and some significant depreciation before getting back in.

  8. Lachlan – I reckon Oz residential RE is maybe 20% overpriced? And I reckon the same about gold. And probably about stocks??? But bubbles seem to be funny things. Just because something is overpriced doesn’t mean it can’t get way more overpriced.

    And there are more ways for a bubble to resolve itself than a crash in absolute $ terms – We can get stagnant asset prices and inflation (stagflation) – Dan Denning seems to be talking about that in this article where he says “… you get low growth, high unemployment, and stock market benchmarks that do not keep up with inflation …” – Although he specifically mentions stocks rather than property.

    My personal punt for Oz for some time has been stagflation. But the RBA reckon it won’t happen because our floating exchange rate will stop us “importing” inflation. (I think we are making our own actually!) But either way, who am I to argue with such an all knowing font of wisdom as the RBA?

    The thought has even crossed my mind that in a global world, in terms of global debt, our Oz property bubble is of no real significance. And to what extent might changes in our exchange rate (which we’ve had a few of) be impacting on it? I don’t understand such things – So I simply ask the question – Because it could be relevant?

    And I also ask myself if just maybe, lots of relatively cashed up boomers (and they do exist – something like 30% of Oz super funds are held in SMSFs with about $800K in each [on average] two member fund – If my memory isn’t too flawed???) may nowadays be happy to accept 3% pa after tax return on their investments – Which could make property sound OK.

    And given such thoughts, I also ask myself if a bloke who reckons Oz RE and gold and stocks are all about 20% overpriced just mightn’t be regarded as “cheap” – Smile!

    I’m tempted to think that we just could “know” within 12 months, what the deal really is regarding RE? But commonsense also says to me even that isn’t true – If Mr Rudd doesn’t like the way the cards are coming up before his next election, he’ll deal some new ones – And everyone of them will be supportive of Oz banks and property.

  9. Nothing wrong with bubbles per se, as long as you know it’s a bubble and play it like it’s a bubble – carefully. We knew the property bubble was (and is) a bubble, but it hasn’t stopped a whole lot of people from profiting from it. Of course from a universal-moral-ethical-touchy-feely standpoint, bubbles are bad because they are signs of economic inefficiency, and usually signs of impending wholesale theft from the middle/lower classes.

    But Ned S, you are absolutely right. Banks and the RE sector are the benefactors of the FHBG, not ‘first home buyers’. It’s just a glossy name for a very nasty piece of policy.

  10. Dan – My initial thought was to call it “nasty” – When the interest rate drops to support it (and other things) took over 50% of my income off me – Smile!

    But the Oz economy isn’t very well balanced – Mining, RE and the Banks that provide the finance to the RE – With nothing else of substance.

    “Pragmatic” perhaps? The “nasty” bit was to portray it as being to benefit the FHB. But then the FHB would have burred up if Rudd said it was to benifit the banks – Smile again!

    Deception and politics are bedfellows. Just maybe the only politician I can think of who wasn’t nasty was Mahatma Ghandi?

  11. Reduce commodity prices.

    Chindia may buy them /their sources at cheaper rates.

    If not today, demand will increase later. Then we can go begging at China to get our Nickel.

  12. We’re all becoming experts on bubbleology now Dan. Maybe a Bachelor of Applied Bubble Timing would help my future prospects.
    Ned I reckon the point about bubbles resolving themselves through inflation(non-asset) is important. As for politicians and lies there is nothing new under the sun is there. Kevin and whoever comes next will keep moving the goal posts but the macro outlook probably wont change.

  13. …i think therefore i am (descartes)….well we do therefore we’re rich (goldman sachs)…

  14. Good luck driving around in your coal-fired vehicle Ned.
    Last time I checked it was pretty hard to make plastic or fertilizer from coal.

  15. It is certainly possible to produce fuel and even crude oil (and hence plastics and the like) from brown coal:$file/Victoria-CoalFuture_FactSheet.pdf

    Whether it is feasible or economic is another question. Certainly there is some growing interest in the process.

  16. Richo you don’t need oil for all types of plastic and people will soon be trying hybrids cars so less oil will be needed there. Technology evolves. What seemed impossible a few decades ago is now possible.

    The main reason we use coal is because it is relatively cheap and there is plenty of it. But as other energy generation technologies develop I suspect coal will be used less. The Japanese for example have greatly reduced their use of coal in power stations over the last 50 years and are one of the most (maybe the most) efficient uses of energy per unit of GDP in the G20. They are also working with electric furnaces to produce steel thus reducing the need for coal in that area as well.

    I think Ned is right, there is no energy crisis and even with existing technology today we could produce all the energy we require. In 20 years time our ability to generate energy will be even greater.

  17. Greg

    I think you are missing the point. Perhaps there is no energy supply crisis, although that is a dubious proposition relative to growing demand.

    The issue is affordability. This is where the crises arises.

  18. Richo – Some processes for converting coal into liquid fuels are listed here:-
    It’s dirty, but happening. And has been around for a long time. Germany made good use of it in WWII as the wiki article mentions.

    Then senator Obama introduced US legislation for what I assume is the same thing in 2007:-

    I gather China isn’t averse to it. I read South Africa is heavily into it – A carry over from the apartheid sanction days apparently? The following even seems to indicate the cost isn’t too bad:-

    I sure don’t pretend it’s ideal right now. Or cheap – Big startup costs with a fear that OPEC could undercut producers anytime they wished I’d imagine – Unless their governments guarantee to protect them presumably? But the basic point still is, that so long as the world has coal, even our existing vehicles can keep running.

  19. Michael, the cost to generate a KwH from wind, solar, coal and nuclear sources is coming down so electricity should actually become more affordable over time. If we are talking about oil then higher prices will just push nations to find alternatives…not a bad thing I would say.

    Anyway even if energy costs a little more per unit you can reduce costs by using it more efficiently. If Australia was to use energy as efficiently as Japan we would knock around 20% off the energy we need per unit of GDP. That is quite a saving and could be done with technology that exists now.

  20. I rank coal gasification (or coal sems gas) as the most feasible way of getting a useful (non-solid) fuel from coal.
    The other techniques have only been used in extreme cases, such as when Germany was losing WW2 and had zero oil imports.

    Wind power to electric vehicles is the economically easy path IMO.

  21. This stuff (hydrogen) apparently gives “zero emission” vehicles – And yes, it is in use, to power big buses anyway:-

    The rub is that you need electicity to produce it. No problem – Go nuclear. Even Pete Garrett seems to be able to cope with that prospect these days – Just not at home of course! Smile.

  22. A new Urea Plant is on the anvil in S-W Coal Belt of Western Australia which will ensure better utilsation of Coal and benefit Agriculture in a big way:

    Bimal Nair
    July 15, 2009
  23. This Chinese coal to liquid facility seems to be one to watch for the prospects of the industry:-

    The article says it’s believed that oil prices of $40 per barrel and more are needed for it to be “free from financial risks.”

  24. Ned : A good article and thanks for the link. If the carbon sequestration issues for direct CTL can be better solved the technology could be applied in Australia . My guess is that oil would have to creep well over USD 100 pbl to break even here.

    Changing the subject completely, China Daily also has an article on the conviction of the former Sinopec boss for fraud. The arrest of the Rio team others, perhaps needs to be interpreted as a rough parallel to the Chen Tonghai case.

    Chinese punishment is, it appears, more lenient that US punishment for this sort of thing assuming the convict can persuade everyone of true repentance. Otherwise it’s a bullet.

    Coffee Addict
    July 16, 2009

Leave a Reply

Letters will be edited for clarity, punctuation, spelling and length. Abusive or off-topic comments will not be posted. We will not post all comments.
If you would prefer to email the editor, you can do so by sending an email to