Is the secular bull market in Vancouver RE over?


Author Cam Hui

Posted: 17 Mar 2012

I don’t generally comment on the local residential real estate scene, largely because the topic isn’t within the scope of this blog and I don’t have much in the way of unique insights. However, I have a personal interest since I live here. In addition, several items came across my desk that piqued my interest.

First, the Conference Board of Canada recently unveiled some research indicating a statistical link between Chinese GDP growth and Vancouver property prices:

Statistical analysis confirms the importance of China’s economic health to Vancouver’s housing markets. Standard tests find significant correlations between the country’s real GDP growth and three important market yardsticks: existing home sales, existing home price growth and total housing starts. By contrast, local employment growth is significantly correlated to none of these and the five-year rate related to only the resale variables. This could mean that a substantial proportion of Vancouver real estate purchasers do not need local jobs to buy any home (new or existing) and that many do not need a mortgage to buy a new home. On the other hand, better economic health in China gives its residents wealth to spend on Vancouver housing.

While statistical relationships do not indicate causality, anecdotal evidence suggests that Vancouver property prices have been buoyed over the last couple of decades by several waves overseas buyers. The first was from Hong Kong, followed by the Taiwanese and now the Mainland Chinese.

The future of foreign demand
I came across an item Friday in the WSJ indicating that the older generation of Mainlanders looked to North America if they intend to emigrate (or at least to get a foreign passport), but the new generation is considering other alternatives such as Singapore, Hong Kong and Cyprus (see video and article). In particular, this wave of “economic refugees” seeking foreign passports as a safety valve should things turn south at home are looking to troubled eurozone jurisdictions such as Cyprus, where you can get a residency permit if you buy property there (and apply for Cypriot, and therefore EU, citizenship after five years). Other eurozone countries like Spain, which saw the collapse of a property bubble, also has a residency for house purchase program.

Yes, I have heard the local real estate boosters. Vancouver is a “world class” city (yes, as “world class” as other Winter Olympics sites like Salt Lake City, Lillehammer, Turin and Sarajevo – can you find them all on a map?). It has a mild climate (as mild as Cyprus or southern Spain?)

So what happens if Mainland Chinese demand starts to decline?

What’s the downside risk?
The Conference Board study indicated that the health of the local economy had little or no effect on local property prices. In other words, the locals have been priced out of the market. At what price does local demand start to put a floor on the market?

Here are some back of the envelope numbers. A typical single-detached house on upscale neighborhoods on Vancouver’s westside goes for about $2 million, give or take. If you were to open up the career section of the local paper, a good paying job is roughly 50-80K a year. Let’s assume that you have a couple with a combined household income of 200K a year – which would roughly puts them in the top 2% in Canada. Assume that they have no other equity from an existing home but have the 20% down payment, they can afford a house of $1.0-1.2 million range based on current interest rates.

That’s where local demand starts to kick in.

With the news that Vancouver real estate market slump is continuing:

Sales recorded through the Multiple Listing Service dropped 24 per cent in February to 4,501 transactions compared with 5,895 a year ago, the report said. The provincial average price was $529,922 in February, down 8.1 per cent from February 2012.

…the concern is that the overseas buyer is looking elsewhere is a threat to the secular bull market in Vancouver residential property prices. Should that happen, market price trends will transform itself from a series of higher lows and higher highs to a more cyclically driven market where prices move up and down with the economic cycle.
Right now, I am watching China (for cyclical effects on Vancouver RE prices, as per the Conference Board study) and emigration preferences (for the secular effects).
Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. (“Qwest”). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest.

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or Mr. Hui may hold or control long or short positions in the securities or instruments mentioned.

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Two perspectives on the “French lion in the grass”


Author Cam Hui

Posted: 30 July 2012

In this week’s essay, John Mauldin characterized France as the “lion in the grass”. He began with the comment that there are certainly lots of risks (lions) in Europe:

We can all see the lions, large and small, of Greece, Portugal, Ireland, Spain, Italy, and now Cypress and Malta. The fear of contagion is what keeps European leaders up at night, trying to figure out how to keep Spain afloat. Because if Spain sinks, the focus immediately turns to Italy.

The hidden risk is in France, Mauldin wrote:

But enough of the lions we can see. Don’t look now, but the lion that lies hidden in the grass is France. Yes, the France that is supposedly a big part of the solution to eurozone woes and Germany’s stalwart partner in guaranteeing all that debt. AAA France. Rated that way by the same people who turned the nuclear waste of subprime CDO squareds, composed 100% of the worst sort of BBB junk, into gold.

Now, the rating agencies are using the same alchemical Philosopher’s Stone to transmute French debt into … fool’s gold.

Today, investors are lending to the French state for five years for less than 1% and its 10-year yields are at all-time lows, presumably it has been lumped in with the likes of Germany as being a safe haven, the French fiscal outlook is dire. In particular, he pointed to an IMF study (actually, I believe that it was a BIS working paper called The future of public debt: prospects and implications). The study examined the debt to GDP path of various major industrialized countries and Mauldin observed that the French debt trajectory look the most like Greece.

BIS Public Debt to GDP projections

Yes, the country most like France is Greece. Yes, THAT Greece. The one that just defaulted. The one that everyone agrees is dysfunctional. Also notice that if Greece were to follow the suggested draconian path, it could stabilize its debt. And then notice that if France were to make the same level of draconian cuts, its debt-to-GDP ratio would merely rise to almost 200% within 25 years. Oops.

Two reactions
I have two reactions to that analysis. My inner investor says, wow that’s terrible. France is an accident waiting to happen. French debt costs will surely blow up and investors need to re-examine the credit risks of any debt paper that they consider. If French yields were to surge because of some event, then risk premiums will also blow sky high and that won’t be good at all for the risk-on trade, i.e. stocks, commodities, etc.

My inner trader tells me that, under the current circumstances, French real interest rates are negative and the France is actually making a profit by running these deficits. It has zero incentive given market conditions to rein in its deficits. In fact, it should be taking advantage of current conditions to extend the maturity of its debt structure in order to lock in low rates.

It’s important to be aware of the long-term risks of the French fiscal path, these kinds of things have a way of not mattering to the market until it matters. As a trader who is measured by the bottom line in his portfolio, he has to be aware of the risk but not hide in the bunker and act on this “lion in the grass” until the lions starts to move. You have to watch for the inflection point.

These differing viewpoints certainly put the Merkel/austerity vs. Hollande/stimulus debate into a fresh perspective.

Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. (“Qwest”). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest.



None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or Mr. Hui may hold or control long or short positions in the securities or instruments mentioned.

Global Debt Problems are Toxic and Likely to End Badly


Author Larry Berman

Posted: 16 May 2012 re-posted from etfcm

We have suggested the downside target for the correction phase is at least 1290, but we did think the 1340 area would initially hold—it has not. The Greek tragedy is manageable from what we understand, but the Portuguese squeeze and Irish break dance, followed by the Spanish paella and Italian salami, is too much for Germany to quaff given France’s new found “AA” foie gras.

Investors are forgetting that the reserve currency of the world, the mighty Greenback—is bankrupt and owes 800% of GDP in unfunded Social Security and Medicare. Even if they patch up Europe for a while with another LTRO or some other alphabet soup, the debt problems in the world are toxic and will most likely end badly. The Euro will likely break up and trillions in debt will need to be written off or monetized globally.

If anyone has another solution, we are searching hard for one, this will likely take years to fully play out. Don’t fret the day-to-day noise and miss the big picture. One needs to take money off the table when the markets are strong and have cash to buy the bargains when they develop.

 

QE3 May Still Be An Option


Author Larry Berman

Posted: 13 Apr 2012 re-posted from etfcm

The gaggle of Fedspeak this week seems to support the notion that QE3 is still an option, but only if the data warrants. So the market seemed to take that to mean a 380K print on initial claims was a shot across the bow that the jobs market is decaying and that will bring the Fed back to the money printing table. If you ask us, the only real politically palatable outcome is an extremely slow shift to better policy making (let me say that again clearly: AN EXTREMELY SLOW SHIFT TO BETTER POLICY MAKING!) taking a decade or more, but in the interim, debt monetization to ease the debt stress and the unavoidable pain of a generation of debt excess. The Piper must always be paid—one way or another.

So risk is on and earnings are likely to be OK this quarter as GDP is likely a bit better than expected. But let’s play close attention to the Google clicks, the Fedex slips, the Intel chips, and the CSX trips to see how the go forward economy is likely to fare. Our bet is that the US economy cannot decouple from the world despite Kudlow’s rants and we are making the next trading top in the next few months.

China: The long and short term views


Author Cam Hui

Posted: 11 Apr 2012

Michael Pettis has a must-read piece on the long-term growth trajectory for China, in which he says that China will inevitably change its growth pattern, either voluntarily or otherwise. Pettis contends that China will rebalance by shifting away from investment driven growth to a growth model based on domestic consumption.

He goes on to say that the government has to stop the financial repression of the household sector and lays out a number of options:

This is the key prediction, and it implies that one way or the other Beijing will engineer a transfer of wealth from the state sector to the household sector. As I see it, the various ways in which this transfer can take place can all be accounted for by one or more of the five following options:

  1. Beijing can slowly reverse the transfers, for example by gradually raising real interest rates, the foreign exchange value of the currency, and wages, or by lowering income and consumption taxes.
  2. Beijing can quickly reverse the transfers in the same way.
  3. Beijing can directly transfer wealth from the state sector to the private sector by privatizing assets and using the proceeds directly or indirectly to boost household wealth.
  4. Beijing can transfer wealth from the state sector to the private sector by absorbing private sector debt.
  5. Beijing can cut investment sharply, resulting in a collapse in growth, but it can mitigate the employment impact of this collapse by hiring unemployed workers for various make-work programs and paying their salaries out of state resources.

He went on to discuss the implications of any potential rebalancing and the implications on the growth trajectory for China:

Notice also that the changing share of GDP tells us little or nothing about the actual GDP growth rate, or about the growth rate either of household wealth or of state wealth. It just tells us something very important about the relative growth rates. For example we can posit a case in which GDP grows by 9% annually while household income grows by 12-13% annually. In that case the rest of the economy would grow by roughly 5-6% annually (household income is approximately half of GDP), and the distribution of this growth would be shared between the sate sector and the business sector. This might be considered the “good case” scenario of rebalancing…

It is worth making three points about these different scenarios. First, in both cases China rebalances, but the way in which it rebalances can have very different growth implications. Second, notice that even in the bad case, household income growth can be quite robust, which means that fears of social instability as Chinese growth slows are very exaggerated if a slowdown in Chinese growth occurs with real rebalancing.

He went on to outline the pros and cons of each policy option, which is well worth reading in detail.

I mostly agree with Pettis. I recently wrote an essay entitled China: the first Axis of Growth for my firm, Qwest Investment Fund Management, which approaches the issue from a slightly different point of view:

This month, we begin the first of a three part series examining the effects of this deleveraging process as it affects the three major trade blocs, in the world, namely China, Europe and the United States. We discuss the challenges that affect each Axis of Growth and the likely growth trajectory that each region will have over the next ten years.

I arrived at a similar conclusion [emphasis added]:

Our analysis begins with China. China faces three challenges over the next ten years. Most immediate is the excessive debt built up from white elephant infrastructure projects on the government side, and a property bubble on the private side. Longer term, China is facing an aging population (see our May 2011 publication entitled China’s long-term growth headwinds) and the prospect of reaching a “Lewis turning point”, where labour productivity falls because China is running out of cheap labour from the rural regions, which pushes up wages and gains from rising labour productivity falls.

We believe that the Chinese leadership is well aware of these issues and are taking steps to address these one by one. Our base case calls for continued Chinese growth as it transforms itself from a growth model based on low cost-labour driven exports and infrastructure investment to one based on higher value-added exports and domestic consumer spending.

In other words, expect the drivers of China’s economic growth to change slowly over time, but growth will continue. What is admirable about Pettis’ analysis is he goes into the implications of different policy options that the government has in order to effect these changes.

What’s the trade?
As interesting as this long-term analysis is, my trader friends will ask me, “What’s the trade?”

Today, China and Chinese related investment plays are showing weakness indicating that slowing growth expectations. While some China bulls have emerged, I see no technical signs of a bottom has been put in place. This Bloomberg TV interview with Patrick Chovanec, an associate professor at Tsinghua University’s School of Economics and Management in Beijing, tells the story of what’s happening on the ground in China. His most important quote was:

When I talk to companies throughout China, there isn’t a single one that’s seeing an increase in profits or revenues.

Here’s the trade: Should China experience a hard landing or commodities crash, my inner investor tells me to be prepared to buy commodity related investments with both hands, largely because commodity intensity rises when incomes rise and consumers want more stuff (cars, TVs, fridges, etc.) [emphasis added]:

The winners of this transformation remains the commodity complex, as rising incomes mean greater resource intensity, and companies focused on the Chinese consumer. We would avoid companies and countries exporting capital goods to China. Japan, in particular, appears vulnerable over the next few years because of its high debt level and reliance on Chinese exports as a source of economic growth.

A slowdown in China should not be viewed as a disaster, but an opportunity to buy into a secular growth theme at better prices.

Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. (“Qwest”). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest.



None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or Mr. Hui may hold or control long or short positions in the securities or instruments mentioned.

Bad news is bad news, good news is…


Author Cam Hui

Posted: 09 Apr 2012

It’s always good to have a long weekend once in a while as it gives me time to think and reflect, rather than to react in a knee-jerk fashion to news. So what to make of the shocker of a NFP release last Friday?

Upon further consideration, it sounds bad as the stock market is caught by the dilemma where bad news is bad news and good news may be bad news.

Why was employment rising so quickly?
Ben Bernanke’s speech to National Association for Business Economics Annual Conference provides some clues. He said that:

[T]he better jobs numbers seem somewhat out of sync with the overall pace of economic expansion. What explains this apparent discrepancy and what implications does it have for the future course of the labor market and the economy?

The apparent discrepancy is due to Okun’s Law [emphasis added]:

Okun noted that, because of ongoing increases in the size of the labor force and in the level of productivity, real GDP growth close to the rate of growth of its potential is normally required just to hold the unemployment rate steady. To reduce the unemployment rate, therefore, the economy must grow at a pace above its potential. More specifically, according to currently accepted versions of Okun’s law, to achieve a 1 percentage point decline in the unemployment rate in the course of a year, real GDP must grow approximately 2 percentage points faster than the rate of growth of potential GDP over that period. So, for illustration, if the potential rate of GDP growth is 2 percent, Okun’s law says that GDP must grow at about a 4 percent rate for one year to achieve a 1 percentage point reduction in the rate of unemployment.

Why are we seeing unemployment falling so quickly when GDP is growing so slowly? Chairman Bernanke explains:

[A]n examination of recent deviations from Okun’s law suggests that the recent decline in the unemployment rate may reflect, at least in part, a reversal of the unusually large layoffs that occurred during late 2008 and over 2009. To the extent that this reversal has been completed, further significant improvements in the unemployment rate will likely require a more-rapid expansion of production and demand from consumers and businesses, a process that can be supported by continued accommodative policies.

Stalling employment gains would provide fuel for policy doves (like Bernanke) within the FOMC for further rounds of QE. As I wrote before (see How easy is this Fed?), the Fed is unlikely to have the political capital to engage in quantitative easing in the 2H as it is an election year. So will the data deteriorate fast enough to warrant QE? They are unlikely to act at the April meeting on a single month’s data, especially when there is a 90% chance that the actual number lies between 20K and 220K. Doves will focus on the falling employment number, while hawks will focus on the falling UNemployment number. What if the next month’s NFP came in around 150K? Will that be enough? I doubt it.

I agree with Tim Duy when he summarized his reaction to last Friday’s NFP release as [emphasis added]:

A disappointing jobs report for those who expected the US economy was about to rocket forward, but one consistent with the slow and steady trend into which the US economy appears to have settled. And no reason to change the basic outlook for monetary policy – the Fed is on hold until the data breaks cleanly one direction or the other.

The markets sold off last week when the FOMC minutes revealed that, while QE3 remained on the table, further rounds of QE are unlikely unless the economic data significantly deteriorates. For now, bad news (on employment) is bad news, unless it’s really, really bad.

Improving employment = Profit recession
What if last Friday’s number was a statistical blip and employment continues to improve? Chairman Bernanke explains:

[A]nother interpretation of the recent improvement is that it represents a catch-up from outsized job losses during and just after the recession. In 2008 and 2009, the decline in payrolls and the associated jump in unemployment were extraordinary…In other words, employers reduced their workforces at an unusually rapid rate near the business cycle trough–perhaps because they feared an even more severe contraction to come or, with credit availability sharply curtailed, they were trying to conserve available cash.

Now that the economy has improved, businesses need to add workers to catch up. Indeed, we can see that from the graph below which shows a picture of rising labor productivity:

The price of rising employment in “defiance” of Okun’s Law is a profit recession, with sales rising but profits falling as the gain begin accruing to the suppliers of labor rather to the suppliers of capital. Ed Yardeni documented this phenomena as he showed that consensus sales estimates have been rising:

…while earnings estimates growth has been stagnant:

In a way, Yardeni is implicitly endorsing this view of employment catch-up with his analysis of the jobs picture before the NFP release.

This outlook is also consistent with Gallup’s observation of falling unemployment, rising economic confidence and improving consumer spending. In addition, the Conference Board also reported that CEO hiring plans are rising.

As we move into another Earnings Season, the interaction between employment and profits bear watching. Whether the inflection point for earnings to start rolling over happens this quarter or next quarter, I have no idea. I do, however, have a pretty good idea of the trajectory of the US corporate earnings for the rest of the year.

Equity outlook: US likely to roll over, does it all depend on China?
So there you have it. If we get good news on the labor front, it means a profit recession, which is bad for the stock market. If we bad news on employment, the Fed’s hands are tied for the second half of 2012 unless the economy really craters.

Looking ahead to 2013, we have the Bush era tax cuts expiring. With little agreement in Congress ahead of an election year, the US is likely to see rising fiscal drag in 2013. As we enter the second half of 2012, the markets will start to look forward and discount slower American growth, which would be negative for stock prices.

Ben Inker, the head of asset allocation at GMO, essentially voiced the similar concerns over potential margin compression as the effects of fiscal drag become more evident next year:

High profit margins are the biggest impediment to returns in the equity markets. “The big issue is profits are at an all-time high relative to GDP,” Inker said. “We don’t think that is sustainable. We think it’s going to come down.”

The question is, why has that occurred amid a relatively weak global economy? And what could cause it to change?

Inker believes the reversal of government budget deficits will kill margins. Profits have risen as corporations have successfully cut labor costs, but that was a short-term gain, Inker said. Normally, wage reductions and workforce cutbacks leave less money for consumers to spend across the whole economy. That didn’t happen over the last several years because the government stepped in with offsetting stimulus measures, allowing disposable income to remain high despite the fact that labor income has been shrinking.

Hence current profits cannot last for long. Even though he expects modest growth in the global economy, lower unemployment and higher capacity utilization, Inker said that “as a necessary condition of decent growth, we need to see profit margins come down.”

Today, US equities are the market leader based on a belief of an improving consumer (see This bull depends on the US consumer), Europe is starting to go sideways on concerns over Spain, Portugal, etc., and China is not showing strength.

My Asset Inflation-Deflation Trend Model moved to a neutral reading early last week (see Time to take some risk off the table), which is the likely correct tactical response for now as the markets aren’t in any imminent danger of tanking dramatically. Looking forward, however, the 12-month outlook for the US are faltering. There are a number of China bulls starting to come out of the woodwork (see example here), but I can see no technical turnaround in Chinese related markets for the moment.

Under these circumstances, the bulls only hope are dependent on a revival of Chinese growth in the 2H, which is a risky bet on timing. While my inner trader isn’t outright bearish, my inner investor tells me that selling in May is starting to sound good right now.

Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. (“Qwest”). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest.

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or Mr. Hui may hold or control long or short positions in the securities or instruments mentioned.

The energy bull still lives


Author Cam Hui

Posted: 06 Mar 2012

Ambrose Evans-Pritchard recently wrote an article entitled Plateau Oil meets 125 Chinese cars, in which he discusses why oil prices haven’t fallen despite the anemic nature of global economic growth [emphasis added]:

What is deeply troubling is that Brent crude should have reached fresh records in sterling (£79) and euros (€94) – with a knock-on effect on US petrol prices, mostly tracking Brent – even though the International Monetary Fund has sharply downgraded its world growth forecast to 3.25pc this year from 4pc in September, and even though International Energy Agency (IEA) has cut its oil use forecast for this year by 750,000 barrels per day (bpd).

Oil is not supposed to ratchet defiantly upwards in a downturn, which is what we have with the Euro zone facing a year of contraction in 2012, and much of the Latin bloc sliding into full depression. Japan‘s economy shrank in the fourth quarter.

The reason is Peak Oil, or Plateau Oil, where crude supply is not expanding to meet rising global demand because of rising emerging market affluence.

Asia’s emerging powers of Asia – the key force driving the commodity boom of the last decade – are in various stages of “soft-landings” after hitting the monetary brakes last year to check property bubbles and curb inflation. China’s manufacturing has been bouncing along near contraction levels through the winter. So what happens when it recovers?

The unpleasant fact we must all face is that the relentless supply crunch – call it `Peak Oil’ if you want, or `Plateau Oil’ – was briefly disguised during the Great Recession and is already back with a vengeance before the West has fully recovered.

The commodity markets are now selling off over China’s new GDP growth of 7.5% as it shifts from export driven growth to internal consumption growth. I would argue that the move is commodity bullish (instead of bearish as interpreted by the market knee-jerk reaction) because resource intensity grows because of the shift to consumption, as shown by this analysis from the Council on Foreign Relations.

Indeed, the emerging market demand story has become so prominent that Big Picture Agriculture points out that Asian oil demand has already risen to exceed North American demand.

Not too late to buy energy stocks
It’s such these kinds of positive fundamentals that makes me a long-term commodity and energy bull – and it’s not too late to buy energy stocks. The chart below shows the price chart of Select SPDR Energy ETF, or XLE, going back to 2000.

I have also constructed a crude trading signal for energy stocks. Below the main XLE price chart, I show the relative performance of the more volatile Oil Services ETF (OIH) against the more stable XLE, which is more heavily weighted with integrated oils. Note that troughs in the OIH/XLE ratio have been good times to buy. Investors would have seen higher prices within a year after each of those buy signals. Moreover, if you had waited for the OIH/XLE ratio to rise by 0.25 to 0.30 after each of those buy signals and sold your position, you would have profited handsomely.

We just saw a buy signal for energy stocks last year. Based on the OIH/XLE ratio, it’s not too late to buy and ride the energy stock bull.

Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. (“Qwest”). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest.

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or Mr. Hui may hold or control long or short positions in the securities or instruments mentioned.

Time to ride the commodity bull


Author Cam Hui

Posted: 30 Jan 2012 12:18 AM PST

Long time readers know that I am a long-term commodity bull. Moreover, I have been writing on the theme of global healing for a few weeks. Despite last week’s disappointing US GDP report, I am seeing signs that it may be time to get on the commodity bull for a ride. Both sentiment and momentum indicators are lining up for another upleg in commodity prices.

First of all, sentiment measures indicate that commodity prices are at levels suggesting accumulation. This chart from Mary Ann Bartels of BoA/Merrill Lynch (Note: the depictions of bull and bear phases are mine, not hers) shows that large speculators, who are mainly hedge funds, have moved off a crowded long in commodity prices. The chart was produced by aggregating the Commitment of Data reports for all futures exchange traded commodities in the CRB Index.

My depiction of the bull and bear phases show that during the bear phases, neutral readings are good times to fade the rally. On the other hand, neutral readings are good opportunity to accumulate positions during the bull phases. The bull and bear phases is best exemplified by the chart of the bellwether of gold prices, which bottomed in 2002 along with the rest of the commodity complex.

Just because there is a neutral signal from this is a good time to accumulate positions doesn’t mean that there isn’t more downside to commodity prices. To see some near-term upside, you need a catalyst.

Bullish CAT guidance the bullish catalyst?
I have offered that one of the key indicators to watch for market direction is to watch the corporate guidance and the body language from management during 1Q earnings season. A bullish catalyst appeared last week when Caterpillar, which is a cyclical company that does business worldwide, reported and gave guidance that was very upbeat :

We expect improving world economic growth to increase demand for commodities. Our outlook assumes most commodity prices will increase slightly in 2012 and continue at levels that encourage investment. We expect that copper will average over $4 per pound, Central Appalachian coal about $75 per ton and West Texas Intermediate crude oil about $100 per barrel.

In particular, mining will be a source of growth in 2012 and growth will be so high that supply will have a tough time with meeting demand:

We expect mining to continue to be strong globally, and we have a sizable order backlog for mining equipment. We expect sales to increase in 2012 and are in the process of adding production capacity for many of our mining products. However, we expect sales to be constrained by capacity throughout 2012.

Moreover, the WSJ showed that the American economy continues to grow despite last week’s disappointing GDP report:

CAT was bullish on the outlook for US housing:

We expect total U.S. construction spending, which, net of inflation, has declined since 2004, to finally begin to recover in 2012. We project a 1.5-percent increase in infrastructure-related construction and a 5-percent increase in nonresidential building construction. We are expecting housing starts of at least 700 thousand units in 2012, up from 607 thousand units in 2011.

They were sanguine on Europe because of ECB support of the eurozone:

The Eurozone public debt crisis has been a lingering negative, but it is unlikely to trigger a worldwide recession. The Eurozone will likely have at least two quarters of weak, possibly negative growth, but should begin to improve in the second half of 2012. For 2012, our outlook assumes economic growth for the Eurozone near zero and growth of about half of a percentage point for Europe in total.

Our expectation for improvement of European growth in the second half of 2012 rests on a continued easing by the European Central Bank (ECB). The ECB has recently lowered interest rates and could cut rates further in 2012.

CAT also saw sufficient growth in China to support construction demand and commodity growth:

China took its first easing action in late 2011, and we expect that further easing is likely. We expect China’s economy will grow 8.5 percent in 2012, sufficient for growth in construction and increased commodity demand.

In addition, Joe Weisenthal highlighted some of the positive long-term fundamental drivers of Chinese commodity demand, namely a population that is rapidly becoming more affluent, which will raise demand for the consumer good life, such as electricity:

…and autos:

So there you have it:

  • A long-term rising demand for commodity prices from emerging market countries like China;
  • A neutral to moderately bullish sentiment environment for commodity prices; and
  • A forward looking bullish outlook from a global company that is highly exposed to cyclical growth.

What more do you need?

Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. (“Qwest”). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest.

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or Mr. Hui may hold or control long or short positions in the securities or instruments mentioned.

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