China

Cracks are not spreading on the façade, real estate sales are not falling, and that the economic engine is not starting to sputter. China has literally been building a Rome a day. But 160 million are expected to move from the hinterlands to urban areas, enough to soak up this excess. The country’s real challenge arises when its demographic pyramid starts to invert in about five years. When that happened in Japan, a 21 year bear market followed. (FXI), (CYB).

With the topic of oil once again dominating the air waves courtesy of Goldman's most recent flip flop on Brent, we look at one of those thing that few if any have actually done much analysis on over the past decade, namely supply and demand. As it is no secret that the primary driver in price formation of virtually all commodities has been excess liquidity, the actual fundamentals have been drowned for a long time. Yet they still remain. Of all "demand fundamentals", the biggest one is and will be China. Should the world indeed proceed to tighten across the globe, the question of Chinese demand will increasingly become one of substantial importance. Here is how Platts sees Chinese oil demand in the next several years: "China's demand for oil will grow 4-5% a year to hit 530 million-560
million mt (10.6 million b/d-11.3 million b/d) in 2015, with transport fuel
and chemical feedstocks driving the increase, a senior Chinese researcher
said Wednesday." Platts estimates that China's current oil consumption is about 450 million mts, a 12.2% increase over the past year. And following 2015, "Growth will then slow to 2%-3% a year, to reach 590 million-650 million
mt by 2020, said Liu Xiao Li of the Energy Research Institute, part of
China's economic planning agency, the National Development and Reform
Commission. With oil production in 2020 expected to be 200 million-230 million mt,
that would imply an import dependence of around 65%, she added." One can thus see why China is ever so cautious proceeding to procure E&P exposure and infrastructure projects around the world: the country realizes that without a friendly foreign "import" base, there is no way it can grow into its energy demand. Lastly, for those who collect parity facts, "in a presentation at the International Air Transport
Association's Aviation Fuel Forum, Standard Chartered Bank said China would
overtake Europe as the world's second largest consumer of oil before 2020,
with around 13 million-14 million b/d of demand. The bank's data indicates China would catch up with the US sometime
after 2030. Standard Chartered's data has China's oil demand approaching 17
million b/d around that year and still rising, with US oil demand around 18
million b/d and falling." Luckily by then we should have far more evidence whether the Peak Oil theory is indeed true, in which case the world will have far greater problems in the next 19 years than anything seen to date.

Following its just announced flip flop on oil, Goldman's "sellsiders" go ahead and not only cut Chinese growth prospects, but raise the Nikkei. So let's get this straight: Goldman raises its prices forecast for oil, even as it downgrades the primary driver of demand - China, and somehow the Japanese market, which suddenly is overreliant on natural resources for energy creation in the aftermath of Fukushima, is supposed to surge... Was this script written in Bollywood? Anyway, for those with a sense of humor, here is the gist on China: "Recent data have been worse than we expected. The growth slowdown has been even sharper than we forecast, especially evident in April industrial production (which mainly reflected tighter monetary and fiscal policy, although some specific industries have seen supply-side constraints). In addition, inflation is not coming down as rapidly as we hoped. We now cut our 2011 GDP growth forecast to 9.4% from 10.0%. This partly reflects the lower-than-expected 1Q2011 GDP print (9.2% qoq ann.), but we have also cut 2Q2011,3Q2011, and 4Q2011 growth to 8.0%, 9.0%, and 9.3% qoq ann. from 8.8%, 9.5%, and 9.7% respectively. This is only very slightly above the last official consensus, which came before the disappointing April data, and so we are likely to be above the true consensus now. We expect annual average inflation of 4.7% (up from 4.3%), with a peak in yoy terms of 5.6% in June. We also nudge down our 2012 GDP growth forecast to 9.2% from 9.5%, reflecting in part the impact of higher oil prices. Although we maintain our annual average inflation forecast of 3.0% in 2012, we have a slight acceleration within 2012 as higher oil prices eventually get passed on more fully." Yet while this conclusion in and of itself makes some sense, the following from Goldman's Kathy Matsui in the Nikkei, regarding the firm's outlook on the Japanese stock market, confirms that whoever is coordinating the Goldman sellside push may have crossed the Tropic of Thunder: "Contrary to popular opinion, we believe the disaster will accelerate - rather than delay - Japan's exit from deflation. We see reconstruction demand and exports driving gross domestic product growth to an above-trend pace of 2.5 per cent in 2012...Market participants have argued for some time that it will take a cataclysmic event to drive structural change in Japan; now the world is watching." Bottom line: China down, Japan up, and oil far, far away. Sigh.

Paul Craig Roberts: "The west prides itself that it is the standard for the world, that it is a democracy. But nowehere do you see democratic outcomes: not in Greece, not in Ireland, not in the UK, not here, the outcomes are always to punish the innocent and reward the guilty. And that's what the Greeks are in the streets, protesting. We see this all over the west. There is no democracy, there are oligarchies, some of these smaller European countries are not even run by their own governments, they are run by Wall Street... There is probably more democracy in China than there is in the west. Revolution is the only answer... We are confronted with a curious situation. Throughout the west we think we have democracy, we hold ourselves up high, we demonize China, we talk about the mafia state of Russia, we talk about the Arabs and so on, but where is the democracy here?"

Christine Lagarde's chances of heading the IMF just took a another step back. Why? Because the firm whose alumni are about to be or already are in key posts at the Fed, the ECB and the BOC, has said (through its moutpiece Jim O'Neill who "can't see how the EUR should be above 1.40" even as Thomas Stolper et al see it going to 1.55 in a year) that it is not too crazy about having a European replacement for DSK, and that "it might be better if some leadership and authority came from outside of Europe with a fresh set of independent eyes" (supposedly the fact that Lagarde has had no formaly economic academic brainwashing is not a factor). In other words, Goldman has aligned itself with China, which has made it clear that it may be wise if the next IMF leadership "reflected the New World Order." As such, the largely symbolic IMF conclave just became very interesting: while the IMF is largely a figurehead with the real backstop organization always being the Federal Reserve, Goldman appears to have just voted alongside China... and thus against Europe and the US.

Following Friday's news that China has now surpassed India as the world's largest buyer of gold, it is becoming increasingly obvious that the country is trying to capitalize on the popular interest in the precious metal by transferring the trading infrastructure away from US to domestic capital markets. First, it recently launched a 1 kilo gold futures contract on the HK Merc in an obvious attempt to undermine the Comex monopoly in the space, and next it seems that China has the GLD plain in its sights, as it plans to start exchange-traded funds, tapping rising demand in China, the world’s biggest investment market for the precious metal. Often blamed for the recent volatility in the price of gold, precious metal ETFs have been primarily an instrument available to those with access to the US market. That appears to be ending, and with an entire nation suffering from gold fever (as inflation continues to be goalseeked by the China politburo above expectations in what appears to be a programmed attempt by the Chinese central planners to push its population into gold hoarding) and about to be offered a simple way of investing in (paper) gold, it is likely that the price of gold (and soon thereafter all other commodities) will see unprecedented spikes in price in either direction as millions more are given direct exposure to trading the non-dilutable currency equivalent.

Gold and silver are higher again today with the debt laden dollar, euro and yen all being sold. News that China has become the world’s largest buyer of gold bullion and has seen investment demand double continues to reverberate in the markets and may have contributed to this morning’s strength. China becoming the world’s largest gold buying nation is very important. While informed analysts have been saying that this would inevitably happen much of the commentary and most of the public remain completely unaware of the huge implications that Chinese gold demand has for the gold market. Chinese investors bought 93.5 tonnes of gold coins and bars in the first quarter. China produced 340 metric tons of gold last year and consumption was about 700 tonnes, leaving a gap of nearly 360 tonnes. Demand is forecast to increase due to the growing wealth of the Chinese middle class and deepening inflation in China. What is most important and rarely covered is the fact that gold ownership by the Chinese public remains minuscule. Especially when compared to other Asian countries such as Vietnam and India.

There was a time when a young Mujahideen commander named Osama bin Laden was a core ally of the US in the fight against Soviet communism and central planning. Well, that particular affair did not end too well for either Osama, nor for the USSR (although one may argue that "communism and central planning" are experiencing a second renaissance courtesy of capitalist central banking). Along the same lines, Pakistan which as recently as 3 weeks ago was considered a core US ally, has very promptly fallen out of favor following the death of that other abovementioned former ally. Yet Pakistan is not wasting time. Two days after Pakistani PM Yousuf Raza Gilani took a direct stab at deteriorating US-Paki relations by saying that China is now his country's "best friend",  China has retorted in kind by announcing it will provide another 50 JF-17 fighter jets to Pakistan on an "expedited" basis. The WSJ reports that "the agreement to accelerate supply of the jointly developed jets, the first 50 of which are being assembled in Pakistan, came as Pakistan's Prime Minister Yusuf Raza Gilani held talks in Beijing during a visit that he has used to portray China as an alternative source of military and civilian aid. "We're getting the 50 jets, on top of the ones we already have. Something has been agreed in Beijing, so they'll be expedited" he said." In other words: step aside US, here comes China. As for those billions in USD aid which somehow never ended up being used to buy US Treasurys (Pakistan is nowhere in the listing of US Treasury holders) , it is now clear into whose pocket they are going (at $15 million a pop, those are big pockets). Lastly, this is more than just posturing by China: the country is clearly indicating its latest and greatest sphere of influence. As a reminder, "It was reported in 2008 that Azerbaijan and Zimbabwe had placed orders for the aircraft and nine other countries, including Bangladesh, Myanmar, Egypt, Iran, Lebanon, Malaysia, Morocco, Nigeria, Sri Lanka and Algeria were showing interest."

There's a funny thing about the New World Order: it eventually gets too big and bites the hand the feeds it. Enter the PBoC: "The new IMF leadership needs to reflect changes in the world economic order and be more representative of emerging market economies, Chinese central bank governor Zhou Xiaochuan said Thursday in his first public comments since the arrest of Dominique Strauss-Kahn. "The senior management team of the IMF should better reflect changes in world economic patterns and should be more representative of emerging market economies." Translation - no more European of American cronies. It is also probably safe to say that Lagarde's odds of pulling the white smoke out of the conclave bag have just plunged. It is also safe to say that with China now unofficially Europe's backstopper (and there were those wondering why China is buying all those Spanish and Portuguese bonds), what China wants, China gets.

In a free market, we wouldn't have unsafe nuclear reactors ...

Following last week's news that as we suggested US stagflation is starting to shift to China, SocGen's Patrick Legland looks at the consequences of what a Chinese slowdown in H2 would look like for the country, and the world. Cutting to the chase: buy Chinese CDS, and sell hard commodities. That said, the risks to the global economy, should China implode, are far vaster, and we fail to conceive how the central planning cartel would ever allow this to happen, or the PBoC for that matter, considering today's earlier news of not one but two failed Chinese auctions.

It was only a matter of time before the combination of a suddenly alienated Pakistan and a top secret stealth helicopter crashed deep in its territory, would raise the specter of China, and specifically its military complex hinting it would be delighted to peek under the dress of said crashed chopper to fortify its expanding stealth program. ABC reports: "Pakistani officials said today they're interested in studying the remains of the U.S.'s secret stealth-modified helicopter abandoned during the Navy SEAL raid of Osama bin Laden's compound, and suggested the Chinese are as well. The U.S. has already asked the Pakistanis for the helicopter wreckage back, but one Pakistani official told ABC News the Chinese were also "very interested" in seeing the remains. Another official said, "We might let them [the Chinese] take a look." Gee, following two weeks of demonization did anyone possibly consider that Pakistan would now scramble to reallign itself with China? Surely not the Clinton stepford wife (or is that husband).

Gold and silver have extended their recovery and may be headed for the fourth day of gains due to the continuing European sovereign debt crisis, Chinese inflation (+5.3%) and the real risk that rising oil and commodity prices are leading to an inflation spiral internationally and stagflation. German inflation data this morning was worse than expected jumping to 2.7% from 2.3% due to surging energy costs and despite recent strength in the euro. This has led to the euro falling against all currencies and especially against gold. The precious metals are likely to be supported later today when US trade deficit data is expected to be poor with still high oil prices leading to a very large expected deficit of $47.7 billion. This should see the dollar come under pressure and support gold. Stagflation or low economic growth, high unemployment and rising inflation is a clear and present danger to the UK, EU and U.S. economies and other economies internationally. This is especially the case in the UK where house prices have begun to fall again and may be set for sharp falls. Internationally, we are seeing significant debt deflation where the value of goods and assets bought with debt are falling (cars, property etc) while the value of finite, essential goods such as food and energy are rising. Safe haven and inflation hedging diversification into gold is likely to continue as inflation is deepening and there is a distinct whiff of stagflation in the air. It is too early to tell whether the recent sell off is over and a further correction is possible however global macroeconomic conditions suggest that gold and silver bull markets are very much intact. This is especially the case due to continuing Asian demand with gold again being bought on all dips in China, India and the rest of Asia.

Summary of takeaways:

• Activity growth was weak though there are some uncertainties in terms of how weak it is.
• The moderation in M2 and power shortages were the likely drivers of the slowdown.
• CPI came in slightly above our and market consensus forecasts, but it nevertheless represented a sequential moderation.

So much for the world's largest economy no longer overheating. CPI came ahead of expectations yet most other key economic indicators confirmed a slow down in the economy, even as borrowing appears to be picking up once again. Could China be exhibiting the very first symptoms of our very own stagflationary squeeze?

• CPI at 5.3%, Consensus at 5.2%, previous 5.40%
• PPI at 6.8%, Consensus at 7.0%, previous 7.3%
• Industrial Production up 13.4%, Consensus of 14.7%, previous at 14.8%
• Retail Sales 17.1%, Consensus of 18.0%, previous 17.40%