Q. As a commodity strategist, could you tell me about the factors of growth that may or may not underpin recovery in the developed world? The US jobs report did not seem too encouraging because of the nuances.
A: U.S. households are still deleveraging, their advances are improving, and this is aiding to a gradual recovery. This is in the wake of a sharp decline in consumption. The housing market continues to be a bright spot, and we have seen an improvement in building sentiment. So we expect construction to continue to grow. Domestic energy production continues to rise, benefiting the particular regions in where the production occurs, in regions like Texas or North Dakota, for instance. But basically, the outlook is of a gradual recovery. A very disinflationary outlook, as far as gold is concerned; companies have no pricing power due to overcapacity and employees no wage bargaining power due to still high unemployment; unit labor costs are falling. Added to this commodity prices have fallen substantially—5-year inflation breakevens are below 2%...
Q. In terms of reviving global growth, is this something that must be done through the US?
A: It looks like the US will be the first. The US is the furthest ahead in the leveraging cycle than any other economy out there. It makes sense that we would see the recovery of the US first, that it would likely approach potential growth quicker than other economies. If you look at the Euro zone, our outlook there is for prolonged low growth and low inflation over the next decade. At the same time, we see China slowing down, which has been a major engine of growth and very important for the commodity market. That slowdown is caused by investment giving out. You have local developers and governments highly indebted, and they’re responsible for a lot of the investment expenditures, which is incredibly commodity intensive. That type of financial model requires high, if not rising, housing and land prices. We expect prices to fall for a number of reasons – fundamentally, overcapacity in the housing market and cities. At the same time, central government bringing in macro-prudential measures to try to bring down prices and halt appreciation. This might be limiting the number of second homeowners or house-betters and the amount of money you’d have to put down off deposit, for instance. The tipping over of the housing market and declining land prices will put local developers and authorities in the red. That will require central government bailout, which in turn will cause the central government to limit investment in the economy as well. As investment gives way, that’s really going to hurt demand for commodities. Given all of this, it’s a very disinflationary outlook for the global economy.
Q. I see two scenarios, one where the US picks up and Europe lags, and one where the US and Europe both pick up.
A: The more likely is the US growth picking up and Europe lagging behind. I can’t really imagine any other situations. We expect at least a decade of very low growth and disinflation in Europe.
Q. What do you think are the scenarios on Chinese and how will the scenarios impact global growth?
A: Chinese growth was in the double digits prior to the financial crisis, and we expect it to come down to around 7.1% by the end of this year, approaching 6 percent by the end of next year. So that’s quite a substantial decline. I think the biggest effects on economies outside of China are greatest for commodities exporters and where the commodity exports are. There are also the effects on those markets who export goods to China, such as Germany.
Q. The value of the dollar has a negative relationship with gold. What is the significance of gold as an increasing proxy currency? Does a gold price collapse necessarily signal a vote on economic confidence?
A: The drivers of gold are many. It has been the case where there have been concerns over fiat-money and an increase in the money supply, but gold certainly has more volatility than a currency. We saw the massive price collapse in mid-April, and gold trades as a hedge against tail risk and inflation. You have to look at not only the relationship of gold with the US dollar, but all these other drivers as well; Inflation, potentially deflation, or tail risks that could lead to credit defaults. And yes, it does signal a vote on economic confidence. It’s one of two things. It’s a realization that rates are slowly going to rise, and that rising rates are good in the expectation of improving the economy and generating growth in the US. We don’t expect growth to be stellar in the US, so it’s really the factor of rising real rates; as real rates rise, the opportunity cost of holding gold rises, and assets elsewhere become more attractive (stocks pay dividends, bonds pay a coupon, cash pays interest, etc.), which is going to be the bigger driver of the gold price.
Q. Would you say that the comeback of the US, in terms of stock market performance and quantitative easing is the end of woes for the financial world?
A: I wouldn’t say that. The US is ahead of the curve, but the woes that we see in Europe are going to continue for a long time to come and china is going to continue to slow.
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