Are investors eyeing the wrong indicators?

published 17 April 2007

The US Labor Department announced a 180,000 increase in non-farm payroll jobs during March and economists had expected a 142,000 increase. It is not exactly as if economists have any credibility in predicting payroll data, never mind that the data is incredibly volatile on a month-to-month basis and subject to material revisions - so why all the fuss?

Market focuses on economic data

The fact that payroll data can affect the current price for bonds and the dollar is in itself testament that traders have very little sense of what is really important. Payroll data is actually a lagging indicator of economic activity, not a leading indicator, but that is a story for another day.

Because of the strong payroll data the dollar rallied and bonds fell. The market was hoping the Fed would lower interest rates in response to economic woes stemming from the real estate fiasco. If the economy is growing strongly the Fed may not lower rates and could even raise rates. Higher interest rates are, of course, good for the dollar; or so they believe.

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As you probably know, I don't believe the dollar is going to hold onto these exchange levels. Neither does the IMF. According to Reuters, in its latest draft World Economic Outlook the IMF argued 'extraordinarily aggressively" for a correction in exchange rates (i.e. for the dollar to fall) to reduce the massive US current account deficit.

Meanwhile China's state run Zhuhai Zhenrong Corp., which happens to be the largest buyer of Iranian crude oil (just over 10%), began paying for its oil in euros instead of dollars. And Japanese refiners, who cumulatively buy nearly a quarter of Iran's oil production, apparently said that while they are still paying in dollars they would be willing to switch to yen if asked. Iran is the world's 4th largest oil producer, and exporter, and has the 3rd largest oil reserves. If this trend takes hold it does not bode well for the dollar. No wonder the US wants to wage war with Iran: when Saddam Hussein threatened to start trading oil in euros instead of dollars he was quickly deposed.

Many traders and investors don't care about stuff like this; it takes too long to have an impact. For most of these guys a long-term investment means holding a position over the long weekend. Instead they focus on payroll data, consumer sentiment, and Ben Bernanke's mood to give them guidance. So let's look at some more US data, just for the fun of it.

Understanding recent economic data

Housing inventory in 18 major metropolitan areas increased by 6.5% in March, well above the 22-year average of 1.7%. It seems that some sellers are not going to wait for spring and are putting their homes on the market earlier this year. The inventory of unsold homes in these 18 metropolitan areas is up 35% from last year.

Month to month economic data is so volatile that one really should not rely on it for anything other than entertainment. Watching the market react to every bit of new data can, however, be quite entertaining.

This week we learned that the service sector in the US cooled down in March, as it did in February, but that factory orders rebounded in February (latest figures released). If we dig a bit deeper into the February factory orders we see that the rebound was mostly due to orders for airplanes, hardly a harbinger of widespread economic growth. Excluding transportation orders, US factory orders actually fell 0.4% in February after falling 5.7% in January. Non-defense capital goods orders excluding aircraft, an indication of business investment, fell 2.4% in February after falling 6.2% in January.

In the US the question is whether the fallout from the real estate sector is going to materially hurt economic growth or not. Meanwhile, in China, the government is seriously trying to curb speculation and liquidity.

Why Chinese banks are skating on thin ice

China will raise its banks' reserve requirements for the third time this year on April 16th. The latest 0.5% increase brings the reserve requirement to 10.5% and comes on top of repeated increases in interest rates as well as curbs on investments in real estate, auto manufacturing and other industries during the past year. Apparently the Chinese government's efforts to curtail investment growth and speculation have had very little impact.

No wonder. Monetary growth in China, as measured by M2, is running at 17.8% and I bet that M3 growth is even higher. Essentially that means the yuan is losing about 20% of its buying power every year so the only rational thing to do is to spend the money as fast as possible. If you hold onto the currency you lose 20%. If you buy something useful you'll at least have something useful and if you gamble with the money you still come out ahead as long as you don't lose more than 20% a year. That is why monetary inflation leads to an increase in the velocity of money and a tendency towards ever more speculation.

Regardless of the rhetoric about prudent monetary policy, management of liquidity and monitoring of debt levels, the bottom line is that the Chinese banking industry is skating on thin ice. Excessive loans for ill-conceived capital projects and an astounding large percentage of non-performing loans simply means extra-ordinary systemic risk for China's financial system. With its centrally planned government and huge foreign exchange reserves the government could always intervene, and I fully expect it to, but that does not mean the country can withstand an economic downturn and financial meltdown unscathed.

We are living in interesting times, and we should make the most of it. Got gold?

First published on Kitco.com (www.kitco.com)

By Paul van Eeden

Paul van Eeden works primarily to find investments for his own portfolio and shares his investment ideas with subscribers to his weekly investment publication. For more information please visit his website (www.paulvaneeden.com). If you would like to read more from Paul, you can sign up to get his weekly commentary at https://www.paulvaneeden.com/commentary.php.