BLUE QUADRANT CAPITAL MANAGEMENT BLOG
Oil Market Recovery In Site
The International Energy Association (IEA) has reported in its most recent monthly Oil Market Report (OMR) for February, that global oil supply declined by 180,000 barrels per day (b/d) in February to 96.5mn b/d. More notably, the IEA also said that preliminary data for February suggested that OECD commercial inventories had declined during the month, marking the first such decline in just over a year. Furthermore, the IEA said it expected total non-OPEC supply to decline by 750,000 b/d in 2016, mainly driven by a decline of 530,000 b/d in the US market, as marginal shale producers cut back heavily on capital investment in new drilling programs.
Emerging Market Corporate Bond Market
Where do the risks lie?The recent rise in corporate bond yields (widening in corporate bond spreads) has been one of the factors driving some of the recent negative sentiment towards global equity markets. The recent rise in bond yields, in part driven by a tightening in USD liquidity, has mainly been the result of the deteriorating global growth expectations and specifically earnings expectations in the energy and broader commodity sectors. As such, default risk or the perceived risk of default has risen markedly over the past six months and, in turn, leading to a general re-pricing of risk in the corporate bond market.
Chinese Private Sector Credit GrowthChinese private sector credit growth or loans extended by the Chinese financial system to businesses and households accelerated to 15.3% y/y in January from 14.3% y/y in December. This is the highest rate of credit growth recorded since early 2013 and provides another indication that a “hard landing” in the Chinese economy is an unlikely scenario for 2016.
The VW scandalWhat does it mean for diesel vehicles, platinum and South Africa? There exists the potential for modestly reduced platinum demand over 1-3 years if fewer small diesel vehicles are sold as platinum is a key component of the catalytic converter found in diesel vehicles.
Physical PlatinumWe have over the past six months built up a large position in the underlying physical platinum metal itself. The rationale is pretty simple, at current prices, almost the entire South African platinum industry is generating negative cash flows after taking capital expenditure into account, a situation which is clearly not sustainable. At some point, either the Rand will have to weaken substantially further or the actual dollar-denominated price of platinum will have to improve.
The US Energy RevolutionUS oil and gas production is expected to increase significantly over the next five years due to the use of new technologies able to unlock vast previously inaccessible oil and gas (shale) reserve formations creating a US Energy Revolution. Increasing US energy production and decreasing net energy imports have important implications for global US dollar liquidity going forward. Increasing US oil and gas production may depress global energy prices, creating substantial risks for major ‘petrostates’. Inherent political vulnerabilities may be exposed, leading to heightened geopolitical risks and risk of major energy supply disruptions. The current disparity in pricing between US natural gas prices and global gas- and oil prices will gradually be narrowed.
Negative Outlook for China Economy, Fixed Investment and Key Global LinkagesThe large growth in credit over the past five years has led to a massive capital misallocation. There exists widespread evidence of a significant capital stock surplus in certain sectors, such as residential- and commercial-property. Chinese fixed investment has averaged 50% of GDP over the past five years, an unprecedented level relative to other economies both past and present. Chinese fixed investment spending has been a major driver of global demand for industrial commodities, particularly steel and iron-ore. A substantial slowing in Chinese fixed investment spending creates substantial downside risks for industrial metals Low global interest rates and access to cheap US Dollar funding has led to the large-scale use of cheap US Dollar funding to finance risky investment projects in China. Unwind of this trade could lead to systemic risks in certain key banking centres, such as Hong Kong and Singapore and Australia by association.
SynopsisSupply-side structural constraints, such as a persistent power deficit and a fractious labour environment, will constrain the country’s ability to expand export capacity Current government policy favours substantial state involvement in the economy. Ill-conceived social policy and high-levels of rent seeking activity will also continue to result in substantial capital misallocation. These dynamics will ensure that the country’s two key economic imbalances, namely the fiscal and current account deficits, will remain large and entrenched as a feature of the country’s economic fundamentals. A depressed commodity price environment, with the exception gold, and higher energy prices will lead to a deterioration in terms of trade, and create additional external headwinds for the economy. Rising global interest rates and a reduction in US Dollar liquidity will make it difficult for South Africa to fund its current account deficit resulting in a sustained depreciation in the currency.
SynopsisCurrent consensus expects continued disinflation in the global economy. US and global labour market dynamics do, however, point to a threat of the return of sustained wage inflation over the next 5 to 10 years. A heightened risk to medium-term inflation outlook is caused by:
- Fundamental dynamics such as lack of infrastructure investment in major developed economies.
- The end of ‘Moore’s’ law and geopolitical-induced disruption to global energy supplies.Memories of the 2008 financial crisis create the risk that policymakers will be slow to react and respond to a return to elevated global inflation.