DABERIAM XXV

May 2006

March, when I last put pen to paper, seems a long time ago. While April was quiet, May has turned into a market bloodbath. The complacency of the markets as we came out of April has been rudely shaken for no reason that has not been apparent for some considerable time. Governments around the world, along with the Central Banks, have been tightening money supplies and raising interest rates. The economic growth in Asia has been driving up all commodity prices but the downward pressure on consumer prices indexes through Chinese industrialisation has kept inflation figures low. This last trend is beginning to change as the Chinese Government reduces the export incentives of its industrial base, and allows its currency to creep up against the dollar, increases the domestic prices of commodities, particularly oil, and is increasing its industrial rates of pay. This inevitably will lead to a rise in prices in the West. Again all fairly predictable. While we seem to be at the low water mark for inflation, the tide is coming in and the pressure on prices that will feed through into the indexes is growing steadily. 

While all the above is not new, perhaps the sub-conscious realisation that Western Governments are losing their credibility is really what is spooking the market. The Russian government seems to have a clear strategy of using its huge energy reserves as a political weapon against the West. The West continues to build gas-fired power stations as its primary new source of energy and replacement source for ageing nuclear and coal fired stations, further increasing dependency on Russian supplies. Another new development in the Russian economic power game is an effort to dominate Europe’s steel industry, an industry dependent on energy. 

China pursues a global strategy of buying and financing commodity resources around the world, gathering up assets in Latin America and Africa, it is also becoming the major customer for Australian raw materials and New Zealand agriculture. 

Global Economic Indicators

World Economic Growth  (World Bank figures)	2005 (est.)	3.20%	2004	3.40%	2003	2.90%
Base rates: 31 May 2006	USD	5.00%	EUR	2.50%	GBP	4.50%
MSCI World Equity Index	31/05/2006	219.319	31/12/2005	203.143	YTD %	7.96%
Gold (PM London Fix $ per ounce)	31/05/2006	653.00	31/12/2005	513.00	YTD %	27.29%
Oil (WTI Crude $ per barrel)	31/05/2006	71.29	31/12/2005	61.04	YTD %	16.79%

Policies that are entirely logical, bearing in mind that China now represents some 15% of world GDP on PPP basis, larger than the Euro zone, and is growing at around 10% per annum. These figures are inevitably having an enormous impact on world raw material resources and will continue to do so for some time to come. It is worth remembering that China represented less than 5% of World GDP, again on a PPP basis, just twenty years ago. 

The two elephants in the room of World economics, Russia and China, are largely ignored in the debates of the European and US politicians. Europe bickers incessantly and is almost wholly distracted by domestic politics and interstate political rivalries, while the government of the USA, distracted by Iraq and Iran, is failing to grapple with the problems of Latin America and other geo-political issues. The failure of Western Governments to produce any strategy to deal with the looming energy shortfall is extraordinary. The USA’s dependence on imported energy has been growing for over forty years; today some 40% of oil and gas has to be imported. Europe’s energy supply situation has been deteriorating rapidly over the last ten years and this deterioration will increase even faster as North Sea production declines.

The rapidly rising prices of commodities are the natural consequence of some twenty years of surplus, which resulted in low prices discouraging exploration. The rapid growth of China and India has absorbed these surpluses and industry and economics will work to correct the situation as higher prices slow down demand and encourage exploration. The economics can only work, however, if Government does not intervene. In the case of energy markets, there is heavy Government intervention and regulation. It has been fascinating to watch the last ten years of UK Government’s energy policy go from an opinion that the solution can be found in windmills, through the confusion of Kyoto, to the shock of realisation of Europe’s dependence on Russian Gas, to the announcement by the Prime Minister that nuclear energy needs revisiting - having previously decreed that nuclear power should be phased out and that the country should sell off its nuclear technology. 

Having said all that, for the near future world industry continues to produce huge productivity improvements that are leading to increased business profitability and prosperity in the West and Asia. Markets are never rational and pessimism is not a profitable strategy.

Damon de Laszlo 
May 2006