Stephen’s Posterous

The Financial Times reported that oil prices rose above $60 a barrel for the first time in six months on May 12, 2009. Oil prices have jumped 85 percent from a five year low of $32 a barrel set in February 2009.

Other raw material prices also increased. Sugar rose to a three-year high. Wheat reached its highest price since January 2009. Tin hit a six-month peak.

The leading global commodity index, S&P GSCI, soared to its highest level since November 2008 and is up 20 per cent this year. The Financial Times article said that traders put the reason at China, which revealed a large increase in raw materials imports, reflecting in part the economic recovery but also Beijing’s attempt to take advantage of lower prices to stockpile commodities.

Iron ore and copper imports reached a record in April 2009, while crude oil imports hit their second-best month at the same time. Traders and bankers have reported a return of hedge fund money into the market and said big institutional investors such as pensions funds were making inquiries about commodities.

Corn prices hit a four-month high. However, Cocoa futures lost 3.9% as early speculative buying vanished and selling interest tied to falling demand gripped traders. Cocoa for nearby May delivery fell $96 to settle at $2,353 a metric ton on ICE Futures U.S. in New York as reported by the Wall Street Journal. Most-active July lost $93 to settle at $2,377 a ton.

The International Cocoa Organization on May 11, 2009, said demand for cocoa is expected to see its largest yearly decline in 50 years due to the global economic recession. U.S. cocoa import data drove that bearish point home, said Jack Scoville, analyst and vice president at Price Futures Group.

U.S. cocoa imports fell 30.6% in March 2009, from February, and were down 36.5% from one year ago, the Commerce Department said on May 12.  Global cocoa bean grindings, a demand signal, are expected to fall 6% in the year to September 2009, the ICCO said. Its previous forecast had estimated just a 2.1% fall. Despite waning demand, the ICCO still estimates a world cocoa deficit of 80,000 to 90,000 tons, as production declines.

Weather in top-grower Ivory Coast has been mostly beneficial for the crop, though concerns are beginning to mount over recent heavy rain and a lack of sunshine.

From FT.com

Crude oil prices have drifted below $50 a barrel this year as the global recession has dented energy demand in the world’s biggest importers. As stockpiles build up, producers have cut capital expenditure on exploration and new production facilities.

But this could be sowing the seeds of the next bubble, some analysts say. Any failure to gear up output to meet the needs of a recovering economy, could create a gap between supply and demand similar to that which drove crude prices to $150 less than a year ago.

Francisco Blanch, head of global commodities research at Banc of America Securities-Merrill Lynch, answers readers’ questions on the impact of recession and recovery on oil prices.

Where will we see the increasing utilisation of alternative energy sources (such as electric powered cars) bring the price of oil to a permanent low, or will the continuous drainage of oil to a point where the resource is fast running out keep prices elevated?

This is the trillion dollar question. In my opinion, $50/bbl oil is not high enough to encourage a massive shift out of oil towards alternative energy. As an example, most biofuels plants around the world will lose money with oil prices below $60/bbl, while wind farms do not really make much sense in a low oil price world.

Will policymakers focus on energy efficiency when oil is a cheaper alternative and other political issues are more pressing?

We believe that continued upward pressure on energy prices will be needed to focus policy on energy efficiency. Limited spare capacity, strong underlying trend demand and the need for efficiency improvements all suggest that energy prices may have to increase again in the coming years relative to other prices in the economy. Our long-term WTI crude oil price forecast is $72/bbl in real terms.

In the midst of a global recession (depression?) with oil demand so low, one would expect prices to be low and remain low, and yet there still seems to be massive volatility in the price on a day to day and week to week basis. Why is this?

Fundamentally, price volatility in the commodity markets is linked to inventories. Commodity stocks, in effect, serve as a cushion to adjust supply and demand shocks in the physical market. In commodities such as oil and natural gas, where there storage constraints are a feature of the physical market, high levels of inventories can result in high levels of volatility.

Thus, we should not be surprised that the massive demand shock resulting from the global economic meltdown has pushed up oil price volatility. Similarly, low inventory levels can also drive volatility up in oil markets, as we saw last summer.

Technically, commodity price volatility is linked to volatility in other markets including equities, rates, credit or FX. I like to say that volatility is contagious. What will happen to oil price volatility going forward? In the second half of this year, we believe that the oil market will tighten and move from a very large surplus into a deficit, as demand stabilises and Opec maintains low output levels.

A tighter balance should mean that oil inventories could start drawing down in the coming months towards their 10 year average. In turn, a shift towards average inventory levels could help bring oil price volatility lower.

In 10 months, oil prices have decreased around 65 per cent. Do you see the recession as the one and only reason for this decrease?

Yes, we believe supply and demand fundamentals, and changes in the money supply and the velocity of money have been the key drivers of oil prices in the last five years. Industrial production across a broad range of developed and emerging economies came down very sharply in the fourth quarter last year and first quarter of 2009.

In the case of Japan, industrial output is now at the same level it was back in 1983, while German and American industrial activity has taken a step back of almost 10 years. These dramatic swings in economic activity are enough, in my judgement, to create such a large swing in prices.

Opec decided at its last meeting not to reduce output. After this decision, and coupled with poor demand and a move away from carbon fuels, can we seriously expect prices of $150+ ever again?

My simple answer to your question is yes, but a more important question perhaps is when. Due to their high exposure to the business cycle, oil prices have been seriously beaten by the current crises and are unlikely to stage a recovery until there are convincing signs that the global economy has turned the corner.

By then, another set of consecutive years of underinvestment in production capacity, coupled with a massive government debt overhang, will end up exacerbating the very same problems that created the most recent spike in energy prices, in my opinion. This situation could develop as soon as 2011 or 2012 and as late as 2015.

Another important factor that could push oil prices to $150/bbl in two to three years could be the tsunami of monetary and fiscal policy measures aiming to offset the recent private sector credit contraction. In our view, it is still uncertain how governments will be able to service the increased debt. In a world of fiat currencies and large government debts, higher inflation is not an unlikely scenario and a run-up in nominal commodity prices could develop.

In addition, with emerging markets poised to grow at a faster rate than OECD economies in the next decade and limited spare productive capacity, commodity markets could be among the first to experience inflationary pressures.

Is for example extraction of oil from the Alberta tar sands developments operationally economic at $50/barrel? What oil price is required to sanction capital expenditure on further tar sands projects?

It is important to differentiate between operational costs to maintain existing facilities and operational and incentive prices for new investments in productive capacity.

The current price level of $50/bbl will keep the existing tar sands projects in Alberta operational, but will not encourage new investment into the sector. As recently as 2008, our equity analysts estimated that new tar sands projects would only make sense financially at $90/bbl. Fortunately, improved labour productivity, lower steel and component pricing, and an end to the cost inflation environment of the 2006-2008 oil sands boom period are bringing incentive prices lower.

For oil sands projects, our equity analysts estimate that a cost reduction of 25 per cent in new projects is achievable over the next few years. If achieved, this could drive the required oil price to generate acceptable returns from $90/bbl back down to the $70-75/bbl range.

Our calculations suggest that the oil industry’s marginal source of supply will fall to US$70-75/bbl. However, we still expect to see continued price volatility around marginal costs particularly in periods of significant positive or negative divergence from trend levels of growth.

How much of the $150 per barrel oil do you feel was the result of institutional investors buying oil futures instead of, for example, asset backed securities as the crisis unfolded? If the impact of such speculation was significant then do you believe that speculators will continue to play a large role in a potential future oil bubble? Or have we learned our lessons for now?

The influx of investment in commodities sparked an intense and politically charged debate last year on whether speculation somehow caused the price of commodities to become disconnected from the fundamentals of supply and demand. Having analysed the available data in detail, we believe there is simply no evidence for that assertion.

Instead, we can find a clear link from sharp changes in monetary policy to abrupt commodity price movements. Looking back thirty years, our analysis concludes that a 1 per cent reduction in real interest rates results in a 17.5 per cent increase in spot commodity prices 10 months later. Our estimate thus suggests that loose monetary policy played a much more important role than speculators in the commodity price rally in the first half of 2008.

If the prospect of a future price bubble is so obvious why are not speculators already driving up the price, which in turn would encourage investment in oil exploration, extraction and refining?

The short answer is that long-dated oil prices are already on the rise. ICE Brent crude oil contracts for delivery in December 2017 closed last Friday at $78.71/bbl, a 60 per cent premium to current spot prices. The oil futures curve is currently pricing in nominal price appreciation of around 6 per cent per annum for the next 8 years.

I would like to clarify, however, that long-dated oil prices are not just driven by ”speculators”. Key participants in the oil markets include consumers, refiners, producers, inflation hedgers and speculators, defined here as investors that have the ability to go long or short any given contract to take advantage of market conditions). At the moment, a number of consumers have re-entered the market to take advantage of relatively low prices to hedge forward consumption.

Is it possible for the world to exceed more than 90 million barrels of oil production per day? If not, what alternatives is Merrill Lynch investing in to fill the demand gap of 10, 15, 20 years from now?

Perhaps 90 million barrels a day is a reachable target, but the chance of world oil production ever exceeding 95 million barrels a day is very low, in my view. On our estimates, if global GDP grows by 3.6 per cent every year over the next decade, annual energy demand will increase by 4 million b/d of energy in oil equivalent terms.

For oil, this figure could mean an annual net increase in global demand of 1 million b/d. Given the natural limits to supply, policymakers will have to shift their attention to energy efficiency. I can not really comment on what Merrill Lynch is investing, but I certainly see the need to increase global energy supply by 1.7 per cent per annum and global energy efficiency by 1.8 per cent per annum every year over the next decade.

What does that mean for investors? I think sectors such as energy productivity, alternative fuels, renewable electricity generation, but also conventional fuels such as coal or natural gas, will all provide very good opportunities over the next decade as we struggle to fill the ”demand gap” left by oil.

Is the persistent contango structure of the future oil market a sign of increasing dislocations in the oil market or is it just the result of normal market expectations? When do you think the curve will go back to its prevailing backwardation structure?

The persistent contango structure is primarily a function of the extremely high level of inventories, and the ongoing supply/demand imbalance. Keep in mind, however, that the second quarter of the year is the seasonally low point in demand. Thus, we should see a sequential improvement in global oil demand based both on seasonal factors as well as on a slight improvement in underlying economic demand.

In my opinion, with the oil market turning more balanced and Opec keeping over 3.5 million b/d off the market, inventories are heading for a draw in the second half of 2009. Thus, we believe that oil prices will likely continue to strengthen in the next six months.

However, long-dated prices are unlikely to follow suit, as the demand recovery will likely be very shallow in 2010. In a market with abundant spare capacity and a tightening balance, the pronounced crude contango should lead to a flatter curve or even to backwardation. Thus, we believe that the term structure of WTI crude oil prices will continue to flatten from here.

Given that some oil resources are uneconomic to exploit at current prices, what price does oil need to reach for post recession demand to be met?

We believe that two forces will need to be at work over the next decade to prevent further oil price spikes: (1) increased investment into the oil sector and (2) increased energy efficiency and substitution. Thus, oil prices need to be high enough to encourage a relatively slow oil demand growth path going forward and oil prices need to be high enough to encourage investment in marginal sources of supply, which we believe are Canadian oil sands and biofuels.

Keep in mind that commodity production utilisation rates are still high compared to other sectors, so any rebound in economic activity will likely have an impact on commodity prices before it hits other parts of the economy.

Low spare capacity availability on a relative basis, strong underlying trend demand and the need for energy efficiency all suggest that WTI crude oil prices may have to average $72/bbl in the long-term in real terms. In turn, a high oil price will keep energy’s share of global GDP above historical averages.

Did Peak Oil get it wrong and now it’s Peak Demand?

No doubt, global industrial production and economic activity has fallen sharply, with OECD economies contracting at an unprecedented rate in recent quarters. However, this extraordinary ”demand vacuum” created by the collapse of the credit bubble could be filled up quickly by demand for durables in Emerging Markets, in our opinion. We estimate that about 1.7 billion consumers sit on an annual GDP per head of $5,000 to $20,000, mostly in Emerging Markets and mostly unlevered.

This bracket of income is a sweet spot for the consumption of durable goods and for taking on leverage, as appetite for washing machines, freezers or cars rises rapidly when per capita income hits $5,000. As a reference point, Americans had a real GDP per capita of $12,000 in 1980 as the multi-decade long credit bubble began, while Portugal did not cross the GDP per capita mark of $10,000 until 1990.

Thus, as a higher consumption of durables comes with a substantial increase in energy use, supply constraints could soon resurface. As a reference point, global energy demand in oil equivalent terms increased by 6 million b/d in 2007. For China, India and other Emerging Markets to drive and fly, we need all the oil we can get, or a viable alternative to the existing transportation technology.

Given that the fall of oil prices have revealed that countries like Russia and Venezuela have failed to diversify their economies outside of commodities; do you see any oil producing economies making progress to diversify their economy in this climate?

Broadly speaking, I think commodity producers have been more cautious with their spending in the past business cycle than during the oil and commodity boom of the 1970s. In Latin America, Mexico, Brazil or Chile are good examples of oil price hedging, economic diversification, and precautionary savings ahead of the commodity price downturn.

In the Middle East, emerging trading centres in the United Arab Emirates or Qatar could well gain increasing traction in sectors such as finance with global taxation on the rise, partly thanks to heavy investment in infrastructure. Similarly, a broad range of commodity producers sit on large Sovereign Wealth Funds that should allow them to endure the oil price downturn.

There is a long-lasting dispute on the impact of speculation on oil prices. Has the relation between fundamental (physical) and financial (speculative) factors changed after the financial crisis, and are oil bourses (ICE, Nymex) gaining influence compared to OTC deals?

In our view, a global misallocation of capital sits at the heart of the current economic crisis. In simple terms, capital markets failed in recent years and channelled too much money into real estate, too little into energy. Having analysed the available data in detail a few months ago, we found no link between speculative activity and systematic price increases in commodity markets.

As part of a general growth in derivatives across all asset classes trading volumes and open interest in commodity derivatives surely increased, but only some commodities experienced significant price swings in the last two years. What has changed after the credit crisis?

Naturally, listed products are gaining ground across all asset classes, not just commodities, as regulators and market participants press for greater transparency and lower credit risk. Still, activity in the over-the-counter market continues unabated because it offers a customized angle that listed markets can’t provide. Having said that, market participants will now choose to clear trades on the exchange to limit counterparty credit risk, when possible.

Opec regularly states that they require an oil price around 70$/bbl to sustain projects. Where do you see Opec production cost at the moment and do you have an estimate of how many projects have already been postponed or cancelled?

Opec production cutbacks have been very significant. From a peak of 30.3 million b/d in July last year, Opec-11 crude oil production has come down to about 26 million b/d, helping create a floor to global crude oil prices. However, actual oil production costs for most Opec members are substantially lower than $70/bbl, perhaps as low as $10-20/bbl.

Similarly, social oil costs for Opec, or the oil price required to balance the member governments’ budgets, differ by country. For Saudi Arabia, Kuwait, Qatar or the Emirates, we estimate that $50/bbl would suffice to roughly bring government budgets into balance, while members such as Iran or Venezuela probably require higher prices of $70/bbl to break even. Then again, we are talking about social costs, not production costs or incentive prices for new supply.

Having said that, new investments in Canadian oil sands and biofuels production require a $70/bbl price tag, but these projects sit mostly outside Opec. So far, over half of all planned oil sands-related projects in Canada have been delayed or cancelled, while many biofuels producers have cut back on their investment plans.

With collapsing global oil prices and the rapidly increasing cost of funding, we expect delays on expensive development projects like Canadian oil sands to continue. Within Opec, we have also seen significant cutbacks in capital expenditures, as financial resources are being diverted to other sectors of the economy.

Currently there is well over 100 million bbls of crude and 25 millions barrels of products in floating storage. This, combined with record shore stocks will surely provide a buffer until production increases to meet any increase in demand and therefore prevent a price bubble?

I agree that there are very low chances of an oil price spike in the next 12 to 18 months, but I also believe the market could start to tighten again in 2011. Remember that 125 million barrels in floating storage is only 1.5 days of global oil demand, so this cushion is not as large as it seems if economic activity ticks up.

However, given the shallow demand recovery ahead, the high inventory levels, and the increased spare capacity in refining and crude oil supply within Opec, I do not see much upside to oil prices until the end of next year.

Our current forecast for WTI crude oil prices in 2010 is $62/bbl. Beyond next year, the limited growth prospects in rich OECD economies stand in stark contrast to the middle income emerging economies.

As I have pointed out in another question, we estimate that 1.7 billion consumers sit on annual GDP per head of $5k to $20k, a sweet spot for the consumption of durables and for taking on leverage. Thus, the medium-term energy demand prospects are a lot brighter as EM economies start to recover.

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Empire of the Surreal, Remembering J.G. Ballard, 1930-2009
By Hal Johnson, WSJ.com

J.G. Ballard's death last Sunday, April 19, 2009, disreputable genre, publishing experimental stories in science-fiction magazines. Though Anthony Burgess championed Ballard, he seemed destined to remain a marginal, cult figure.

Then his 1984 novel "Empire of the Sun" was shortlisted for the Booker Prize; Steven Spielberg bought the movie rights; suddenly Ballard had both a mainstream audience and literary respectability. His muse, though, was not one to bow to expectations: Ballard's follow-up novel was a surreal, apocalyptic "Heart of Darkness" pastiche. Longtime fans were not surprised.

"Empire of the Sun" is an autobiographical novel set in World War II China, where Ballard spent his boyhood. Ballard was born in Shanghai in 1930 and his experiences there, stranger (his narrator says) than Alice's through the looking glass, helped form his later fiction.

"'Empire' showed us where Ballard's imagination had come from," Martin Amis wrote, or rather complained, in 1996. "The shaman had revealed the source of all his fever and magic." The source proved to be a Japanese prison camp, where Ballard spent over two years, but the fever and magic Ballard brought from it were all his own.

Ballard's early work is rather conventional science fiction. His first novel was of the genre that critic Brian W. Aldiss has called "cozy catastrophe," apocalyptic fare similar to John Christopher's best-selling "No Blade of Grass," and Ballard's short stories fell well within the parameters set by the British science-fiction pulps.

In "New Worlds" magazine, though, editor Ted Carnell encouraged Ballard to experiment, and by the time Michael Moorcock took over the magazine's reins and trumpeted the beginning of a new wave of British science fiction in 1964, Ballard had a good head start.

For the first issue of Mr. Moorcock's "New Worlds" he contributed an essay on William S. Burroughs, an obvious influence on Ballard as his fiction became increasingly experimental and self-consciously avant-garde. One 1969 short story, for example, "How Dr. Christopher Evans Landed on the Moon," is narrated completely through a data printout indicating a spaceship's rate of descent, rate of fuel consumption, etc.

A plan to print a, frankly unreadable, novel on billboards was never realized, but Ballard did manage to insert a series of short pieces, a combination of erotic photographs and gnomic text ("Fiction is a branch of neurology. . . .") -- disguised as advertisements in British magazines. "I would liked to have branched out into Vogue and Newsweek," Ballard explained, "but cost alone stopped me."

It is experimental subject matter as much as form, though, that Ballard is known for. The notorious "Crash," filmed by David Cronenberg in 1996, documents the obsessions of a certain James Ballard with the erotic possibilities of car accidents. Its epic 125,000-word manuscript was pruned mercilessly for publication, but what remains is still a document unique in the annals of science fiction.

A short story detailing the unmentionable things Ballard wanted to do to Ronald Reagan, in addition to garnering infamy for being declared obscene in Britain in 1968, promises to provide readers with "a unique ontology of violence and disaster."

Ballard's fictions were soon all to be ontologies of violence and disaster. A wounded man stranded on a highway divider builds a life, like Robinson Crusoe, out of car parts and fatalism. The denizens of an apartment complex withdraw into a self-contained but atavistic world.

A group of pilgrims trek across a primitive America that dimly remembers celebrities and corporate culture, en route to a self-styled president who has also dubbed himself Charles Manson. The same obsessions appear again and again: car wrecks, empty swimming pools, the notion of geometry, murder.

Ballard's popular success, "Empire of the Sun," simply offers these themes in a more accessible form, with the science fiction trappings stripped away. Violence and disaster are more acceptable in a war novel.

The Collins English Dictionary, in defining "Ballardian," has established for all time a view of Ballard's mature work, work characterized by "dystopian modernity, bleak man-made landscapes and the psychological effects of technological, social or environmental developments."

This makes Ballard sound like a latter-day Kafka, but Ballard's landscapes are never landscapes of despair. His protagonists learn to live in their dystopian worlds, if not happily then at least complacently. To view the modern world as a dystopia, one must have a romantic view of some past Arcadia, Orwell's village green or Huxley's enlightenment humanism, and Ballard is too modern for such nostalgia.

"I was brought up in a world which was new," Ballard said in a 1975 interview, referring to postimperial Shanghai, "so the past has never meant anything to me." The modern world, for all its flaws, is at least as beguiling in Ballard as it is terrifying.

Rather than cultivate the outré stance of the avant-garde artist, it should be noted, Ballard, throughout his life, appeared in all respects to be a normal, even bourgeois, family man. After his wife's death in 1964, an event fictionalized 20 years later in "The Kindness of Women," he raised their three children and lived a quiet, respectable life. Some have viewed this as a sort of irony, but it is, rather, the theme of much of his work. It is the everyday, in Ballard, that is surreal.

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China reveals big rise in gold reserves
By Jamil Anderlini in Beijing and Javier Blas in London, FT.com

China has quietly almost doubled its gold reserves to become the world’s fifth-biggest holder of the precious metal, it emerged on April 24, 2009, in a move that signals the revival of bullion after years of fading importance.

Gold rose to a three-week high of more than $910 an ounce after Hu Xiaolian, head of the secretive State Administration of Foreign Exchange, which manages the country’s $1,954bn in foreign exchange reserves, revealed China had 1,054 tonnes of gold, up from 600 tonnes in 2003.

The news could spark interest in gold among other central banks. “When the largest holder of foreign exchange reserves discloses an increase in gold holdings, other countries may decide to think more carefully about underweight gold positions,” said John Reade, a precious metals strategist at UBS.

The increase in China’s gold reserves has come primarily from domestic production and refining. However, the news raises questions about the future of Beijing’s foreign reserves policy. Ahead of the G20 summit in London this month, China suggested global reliance on the US dollar as a reserve currency should be reduced.

China has been diversifying away from the dollar since 2005, when it broke the renminbi’s peg to the US currency and officially marked it to a basket of currencies, but it still holds more than two-thirds in US dollar-denominated assets by most estimates.

As its trade surplus and forex reserves ballooned in recent years, Beijing continued to buy huge amounts of US Treasury bonds while raising the proportion of purchases it allotted to other currencies and to gold.

China’s accumulation of gold has taken place as European central banks have gradually cut back back gold sales following a 1999 agreement to prevent the market from being flooded after prices were dragged sharply lower after the UK decided to sell part of its reserves.

“China’s announcement signals a broader shift in central banks’ attitude towards gold,” said Philip Klapwijk, chairman of GFMS, the precious metal consultancy.  Suki Cooper, a gold analyst at Barclays Capital, said China’s move was “reigniting gold’s relevance as a monetary asset”.

European central banks agreed to limit gold sales to 500 tons a year in 1999, under the Central Bank Gold Agreement after a UK decision to sell part of its gold reserves dragged prices sharply lower. 

Since 1999, central banks in Europe have sold large amounts of gold, investing the proceeds into bonds. But in the past two years they have curtailed their sales significantly while central banks outside Europe became net buyers of bullion.

China’s forex reserves grew from $623bn at the start of 2005 to $1,906bn at the end of September last year but in the last six months the spectacular growth has slowed to a virtual stop, with reserves rising by just $7.7bn (€5.8bn, £5.2bn) in the first quarter.

That means smaller new purchases of everything from US Treasuries to gold. Paul Atherley, Beijing-based managing director of Leyshon Resources, said that even after the latest purchases China had a very small percentage of its reserves in gold, far below the US or other developed countries.

“Those [gold] holdings are still too low in terms of the size of its economy and the growing significance of its currency,” he said. The announcement boosted gold prices to a three week high above $910 an ounce as investors bet other countries could follow.

Russia has being an active buyer, following Beijing’s similar pattern of purchases from local miners. China became last year the world’s largest producer of gold, outranking South Africa.

Since the financial crisis started, investors have piled record amounts of money into gold, boosting prices to above $1,000 an ounce. Gold hit a low of $250 an ounce a decade ago, when central banks started selling the metal.

Additional reporting by Chris Flood

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Commodities Throw a Curveball by Liam Denning, WSJ.com

Despite big swings this week, oil prices have been stable, bobbing around the $50-a-barrel mark, plus or minus 10%. This is remarkable when you consider that fundamental supply and demand data have been bearish.

This month, the International Energy Agency raised the specter of early 1980s-style demand destruction. In terms of days of supply, commercial-oil inventories in the industrialized world are higher than in 1998, when crude crashed to $10.

Some take hope from the upward slope of the oil-futures curve, known as contango, interpreting it as indicating higher prices ahead. This view is misguided. Indeed, the extreme steepness of the current contango, with oil a year out trading 20% above the May 2009 contract, points to a more complex situation.

Energy economist Phil Verleger makes a robust case for the market impact of speculators, although not in the way you might think. Contrary to the widely held viewpoint that speculators were to blame for the spike in oil prices last year, movements in the price of oil and many other raw materials display virtually zero direct correlation with flows into and out of commodity funds.

This money, much of it passive, does, however, affect the shape of the forward curve. An upward-sloping curve is indicative of there being a surplus of oil relative to real demand. Funds buying oil futures push up forward prices, steepening the curve's upward slope.

For the traders selling the contracts to them, this presents an incentive to buy cheaper physical barrels and put them in storage for delivery at higher prices down the road, hence high inventories. This removes some oil from the market, putting a floor under spot prices. Supply cuts by the Organization of Petroleum Exporting Countries help in this regard, too.

Relying on investor optimism and cartel cohesion to maintain stable prices even as global economic forecasts worsen, however, requires nerves of steel. If faith in peak oil crumbles further, or financing tightens again, lower demand for futures would reduce the steepness of the forward curve. That, in turn, would erode profits on the oil-carry trade, leading speculators to liquidate inventories, likely hammering prices.

Optimism regarding industrial metals rests on similarly fragile foundations. Bellwether copper is up 43% since late February 2009. This head fake comes courtesy of China cannily stockpiling inventories of raw materials like copper and iron ore even as demand contracts virtually everywhere else.

Stockpiling, however, isn't consumption. The surge in Chinese imports hasn't been matched by increases in industrial production, suggesting metals are going into warehouses, not factories. Oddly, despite the country's apparently insatiable demand for iron ore, big price cuts are expected this year. Like the oil overhang, when those inventories get "mined," prices will likely suffer, transforming the head fake into a major headache.

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Jim Rogers Isn't Buying a U.S. Stock Rocovery by John Kimelman, Barron's Online

Bank executives and investors can breathe a sigh of relief: Jim Rogers has covered the short positions on financial stocks he put in place ahead of last year's massive meltdown.

But just because this influential investor isn't betting that big banks will fall much further doesn't mean he's confident they will stage a lasting rally either. He feels similarly about U.S. stocks in general.

"I am skeptical about the rally, and the world economy for the next year or two or three," he says. "But if stocks go down, I can make money with commodities."

Rogers, now 66, gained fame as George Soros' hedge-fund partner in the 1970s and 1980s. After retiring from professional money manager in his late 30s, the Alabama native tooled around Europe, Asia, Africa, and Latin America visiting emerging markets, one by one. His resulting book, Investment Biker, helped to popularize emerging market investing at the outset of a bull market for the sector.

He also helped to popularize commodity investing, which for decades was the province of niche investors. In the 1990s, he developed commodity indexes based on futures contracts that in recent years have been turned into exchange-traded funds available to all investors. His 2004 book, Hot Commodities, came ahead of a surge prices for energy, metals, and agriculture.

Since its inception in July 1998, the Rogers International Commodities Index has gained 158%, while the S&P 500 has fallen 23%. And that gain for the commodities index comes despite the fact that it's lost more than half of its value since last July. At these levels, Rogers has been a buyer.

These days, Rogers, now 66, is sticking close to home in Singapore with his wife, Paige Parker, and two small daughters. He's about to release his latest book, A Gift to My Children: A Father's Lessons for Life and Investing in which he encourages other people's children to travel widely and learn Mandarin so they can reap the rewards of China's economic boom.

Recently, Rogers talked to Barrons.com by phone from his Singapore home.

When you last did a lengthy interview with Barron's magazine a year ago you were lightening up on emerging markets investments. Well, you called that one right. But now that many of those markets have fallen from their highs of recent years, are you more optimistic?

No. I've sold all emerging markets stock except the ones in China. I bought more Chinese shares in October and November during the panic, but I have not bought China or any other stock markets including the U.S. since then. I'm not buying anything in China right now because the Chinese market ran up maybe 50% since last November.

It's been the strongest market in the world in the past six months and I don't like jumping into something that has been that run up. Still, I'm not thinking of selling these stocks either. I think if it goes down I'll buy more. I think you will find that it's the single strongest market in the world since last fall.

In your latest book, you talk of China as the great investment opportunity of the 21st century, just as the U.S. was in the 20th century. What percentage of a typical American investor's portfolio should be in China?

If they can't even find China on a map, I don't think they should have anything in China. They should know something about China before they invest there. If they have the same convictions that I do then they should probably have a lot. If you asked me that question in 1909 about the U.S. stock market, I would have said to put 100% of your money in the U.S.

Might it make sense to have a greater weighting in a diversified mix of Chinese stocks than in U.S. stocks?

Well yes. Just as in 1909, if you were German or Chinese, you should have had the largest percentage of your money in the United States. The idea of investing is to make money, not to have some sort of political agenda.

That being said, you currently think Chinese stocks are bid-up now, so you're not buying at these levels. So what have you been buying lately?

I have been buying commodities through the Rogers commodity indexes I developed because my lawyer won't let me buy individual commodities. I recently bought the all four Rogers indexes, the Elements Rogers International Commodities Index (ticker:RJI) as well as the three specialty indexes, the International Metals (RJZ), the International Energy (RJN), and the International Agriculture (RJA.)

That's how I invest in commodities and that's what I bought last week. I have been buying these shares since last fall and up to last week.

Though you got out of emerging markets last year before they fell hard, you seemed be caught by surprise by the fall-off in commodity prices last year. Is that right?

Yes, I was surprised. I did not expect commodities to go down that much and in retrospect it was a period of forced liquidation for many (professional) investors. You know AIG went bankrupt, which was huge in commodities. Lehman Brothers was big in commodities.

But at least I was shorting the investment banks at the time and other financials such as Citigroup and Fannie Mae. So I was hedged by being long commodities and short the other things such as financials and as you know most of them were down from 80% to 100%, so I more than made up on my shorts than I lost on my longs.

So thank God for (the stock decline in) Citigroup and thank God (for the decline) in Fannie Mae.

Now despite the recent stock-market rally that started in March, many U.S. stocks are trading well off their 2007 highs. How come you see no value to this market?

I am not buying U.S. companies mainly because I think we may have seen a bottom but I don't think we have seen the bottom. I am skeptical about the rally, the world economy for the next year or two or three. But if stocks go down, I can make money with commodities. In the 1970s, commodities went through the roof even though stocks were a disaster. In the 1930s, commodities rallied first and went up the most long before stocks pulled it together.

Can you summarize the reasons for your bullishness about commodities?

It depends on the supply and demand. And we have had a dearth of supply. Nobody has invested in productive capacity for 25 or 30 years now. The inventories of food are the lowest they have been in 50 years and you have a shortage of farmers even right now because most farmers are old men because it has been such a horrible business for 30 years.

And as for metals, nobody can get a loan to open a mine as you know. Who is going to give you money to open a zinc mine? It takes at least 10 years to open a mine so it's going to be 15 or 20 years before we see new mines come on. Nobody has been opening mines for 30 years and they are not going to.

And in the meantime reserves are declining. As for oil, the International Energy Agency came out recently with a study showing that oil reserves worldwide were declining at the rate of 6% or 7% a year.

That does not mean that if suddenly the U.S. goes bankrupt that everything won't collapse in price. But I would rather be in commodities because it's the only thing I know where the fundamentals are improving.

They are not improving for Citibank or General Motors but the supply situation in commodities is such that when demand comes back, then commodities are going to be the best place to be in my view.

What do you think of bonds?

I am anticipating shorting bonds, the U.S. long bond. It's about the only real bubble around that I can see right now -- other than the U.S. dollar. I am not shorting bonds at this moment because I've shorted plenty of bubbles in my day, and I have learned that you better wait because they go up higher than any rational person can anticipate. But my plan is to short the long bond in the U.S. sometime in the foreseeable future.

I've read that you think the penchant of the last two presidential administrations for bailing out failing U.S. companies is a big mistake and will contribute to prolonging this recession. You argue that it's best to let these companies all go bankrupt. How bad can the economy get?

Yes, politicians are making mistakes. In Japan, the problem has lasted for 19 years. I hope that it doesn't last 19 years in the U.S. The approach that works is to let them (U.S. banks and automakers) collapse and clean out the system.

The idea that phony accounting is the solution (through changes in mark-to-market rules) is ludicrous. And the idea that a debt problem and an excessive spending problem can be cured with more debt and more spending is ludicrous.

It's laughable on its face, but politicians think they've got to do something. Unfortunately, they are doing the wrong things and they are going to make it worse.

Thanks for your time.

Source.

A cave complex blasted out of the rocky coastline on China's southern island province of Hainan is home to one of the newest and potentially most lethal weapons in Beijing's arsenal: a home-grown submarine designed to launch nuclear-armed ballistic missiles.

So when the USNS Impeccable, a U.S. surveillance ship, was snooping in the area last month, China set a trap. Five Chinese vessels crowded around the U.S. ship. Crew members hurled chunks of wood into the Impeccable's path and used poles to try to snare its acoustic equipment. When U.S. sailors turned a fire hose on their assailants, the sodden Chinese crew aboard one of the vessels stripped to their underwear and closed to within 25 feet, the Pentagon said.

The encounter in the South China Sea, which lasted for about 3½ hours, was intended to send a clear message. China says the Impeccable was violating international law by conducting surveillance activities in its exclusive economic zone. The U.S. and many other nations view such activity as legal.

When U.S. surveillance ships visit the area in the future, says Su Hao, director of the Center for Strategic and Conflict Management at China Foreign Affairs University, "they'll be more cautious."

The Pentagon views China as the country most likely, at some point down the road, to acquire the capacity to challenge the U.S. military on a global scale. The U.S. in recent years has moved to strengthen its forces in the Pacific and urged its ally Japan to do the same.

Washington and Tokyo are working together to boost anti-missile defenses, to defend against threats from both North Korea and China. And some in the Defense Department talk up the "China threat" to justify greater spending on new weapons systems.

This week, Adm. Wu Shengli, the top officer in China's navy, officially known as the People's Liberation Army Navy, said the service would move faster to modernize its arsenal and build larger and more capable warships "to boost the ability to fight in regional sea wars" using high-tech weaponry.

In an interview with China's official Xinhua news agency ahead of the navy's 60th anniversary next week, he also said the navy would improve its ability to operate on the high seas. Other officials in recent months have talked about China building its first aircraft carrier, adding to U.S. concerns that China wants to project its power.

However, many observers, both in China and the U.S., say that fear of China is exaggerated. China's armed forces are still no match for U.S. firepower at sea, on land or in space. Many American security analysts, including former senior military officers, do not believe that China intends to take on the U.S., as the former Soviet Union once did.

For now, China's military falls back on a mix of high-tech weaponry, such as its new Jin-class nuclear-missile submarines, and low-tech stealth and cunning.

Chinese leaders say that their country's economic rise will be peaceful. However, it is accompanied at times by a strident nationalism, a desire to restore what many people in the country see as China's rightful place in the world, stolen by 19th-century Western imperialists and 20th-century Japanese militarists.

China's belligerence toward Taiwan and its military secrecy make it easier for hawks from Washington to New Delhi to paint a picture of a vengeful China plotting its comeback.

North Korea's failed launch of a ballistic-missile-like rocket on April 5, 2009, complicates the situation. It is likely to spur Japan to strengthen its military and invest more in missile-defense efforts, in which it is now cooperating with the U.S. That could add to tension with China, which already views the U.S.-Japan alliance as a partnership designed to constrain Chinese power.

China yearns for stability on the Korean peninsula, fearing that if North Korea collapses, a wave of refugees will spill over its borders, and it will end up face-to-face with U.S. forces stationed in the South.

According to the Chinese government, the country's defense budget for 2008 was $60 billion, up nearly 18% from a year earlier. The Pentagon believes China's official figures substantially underestimate actual defense spending.

It estimates that China spent $105 billion to $150 billion on military-related expenses last year, as its military transforms itself from a low-tech mass army designed to fight a war of attrition against invaders to a more sophisticated, agile force capable of projecting power beyond China's borders.

China's main focus in modernizing its military over the past few decades has been preventing Taiwan from establishing formal independence and stopping any effort by the U.S. to come to the island's aid in a crisis.

Now some Chinese naval officers talk of one day patrolling as far as the Indian Ocean, conjuring up images from China's imperial past 600 years ago, when a towering armada of treasure ships led by the Chinese Muslim eunuch Admiral Zheng He, or Cheng Ho, sailed through those waters on its way to east Africa.

Despite protests that its more capable navy should be no cause for alarm among neighboring states or Washington, Chinese ships and submarines have been pushing farther offshore. In at least some cases they've tested the defenses of other nations and telegraphed the Chinese navy's intentions to be a player on the high seas.

Some U.S. military analysts now see a broader threat to American domination of the seas, linked to the spread of Chinese trade and economic influence around the globe. If China can challenge a U.S. surveillance ship off its coast, they are asking, might the rising Asian economic superpower in the future aggressively patrol its maritime trade routes in the Strait of Malacca, through which most of China's vital oil supplies pass, or even the Persian Gulf?

The pessimistic view says as much about the anxieties of the world's sole superpower as it does about Chinese capabilities.

Historically, the West has projected both fantastic hopes and dark anxieties upon China. Sentiments veering between the two extremes have long confused the West's relations with the Asian giant.

A conflicting dynamic is now at work in relations between the U.S. and China, arguably the most important relationship of the 21st century. While economic forces are pulling the two sides closer as China has become America's largest creditor, military ties have stalled.

Generals and admirals in the Pentagon have objected to China's challenge in international waters where their Navy has operated for more than half a century, even if those waters are right on China's doorstep.

In his testimony to the Senate's armed services committee, Adm. Timothy Keating, the officer in charge of American forces in Asia, said that the interception of the Impeccable off Hainan Island showed that the Chinese are "not willing to abide by acceptable standards of behavior."

Mr. Su of China Foreign Affairs University says the world fundamentally misreads Chinese intentions. China is a land power, he says, concerned about safeguarding its border regions and consumed by its desire for internal security and cohesion. To those who see menace in China's seaward expansion, he offers this advice: "Relax."

The Pentagon's latest annual report on the Chinese military, published late last month, was widely criticized within China as biased and alarmist.

The report says that "China's ability to sustain military power at a distance remains limited," but notes that its armed forces continue to "develop and field disruptive military technologies" that are "changing regional military balances and that have implications beyond the Asia-Pacific region." It also said: "Much uncertainty surrounds China's future course."

The report "exaggerates Chinese military power" by overestimating the country's ability to project force beyond its own territory, says Yuan Peng, director of the American Studies Institute at the China Institutes of Contemporary International Relations in Beijing.

"Chinese military power is still at a developing country's level. It lags far behind the U.S., Russia and even Japan and India in some senses."

In Mr. Yuan's view, American anxiety, after blows to the national psyche from the Sept. 11 terrorist attacks and the ongoing financial meltdown, goes well beyond China's military advance. "What makes people nervous is not really our military, but China's economic rise and the Chinese political model," he says. "China is rising so fast, the population is so big and the social system is so different" that it excites unease.

Still, China's massive bulk, its continental size and vast population, looms over Asia, and its military modernization threatens an arms race in the region. Japan, heavily dependent on crude oil and raw materials from the Middle East and Australia, worries that one day it may run into a hostile Chinese navy along the same sea lanes that feed China's rapid growth.

Some Indian strategists worry that China is gaining an ability to disrupt its ocean trade, and is encircling it through diplomatic and military links with neighboring countries from Myanmar to Pakistan.

Among the biggest worries for the U.S. is China's improved submarine fleet, which could delay or prevent U.S. aircraft carrier battle groups from responding to a crisis in and around Taiwan, the island that Beijing has pledged to bring under its rule, by force if necessary.

China aims more than 1,000 missiles at Taiwan to deter any attempt by the island's leaders to formally establish independence. China has also acquired eight Russian kilo-class submarines, which are very hard to detect when submerged, and is building its own attack submarines.

Some of the newer ships and submarines in China's fleet are equipped with Russian-made anti-ship cruise missiles that can fly at supersonic speeds. Those missiles, and an anti-ship ballistic missile under development, appear aimed at giving China the ability to strike U.S. aircraft carriers, say U.S. naval officers. Aircraft carriers have been the mainstay of U.S. maritime power for decades.

While China has no aircraft carriers of its own, Chinese officials have started talking publicly again about adding one to their own fleet. Chinese shipyards would likely have little difficulty building the type of mid-sized carrier most analysts expect China to launch. But mastering the operations of a carrier task force and its aircraft would probably take many years, analysts say.

Chinese navy officers believe that their forces must be able to push beyond what they consider the first island chain -- running south from Japan and around the east side of Taiwan -- that stands between China and the broad expanse of the Pacific Ocean. Being able to move ships and subs out into the Pacific would be critical to Chinese efforts to block or delay the approach of U.S. ships to Taiwan or the mainland.

China's fleets have been pushing farther offshore. Last October, a flotilla of four Chinese navy ships, including a Russian-built guided-missile destroyer and two of the country's most-advanced frigates, passed through the narrow Tsugaru Strait between the main Japanese islands of Honshu and Hokkaido and out into the Pacific Ocean. Japanese saw it as a demonstration of China's growing might.

Chinese submarines have also been detected a number of times nosing around Japanese waters. In 2004, a submerged Chinese sub passed through another narrow strait in what the Japanese considered a violation of international law. U.S. and Japanese defense officials interpreted it as a possible effort to map and gather intelligence about routes from the East China Sea to the Pacific.

The new naval base on Hainan, which appears large enough to accommodate surface ships as well as attack and ballistic-missile submarines, gives China's navy direct access to vital international sea lanes. It could allow submarines to deploy stealthily into the deep waters of the South China Sea, the Pentagon says.

Analysts from the Federation of American Scientists who have examined satellite images of the Hainan base say it also appears to have a facility of the sort used by the U.S. Navy to demagnetize nuclear-missile submarines before they deploy, to make them harder to detect.

If that were true, it would indicate China's intention to use its ballistic-missile submarines as an active part of its nuclear deterrent. The federation says that there is no evidence that China's previous generation of nuclear-missile-carrying submarine ever carried out a single deterrent patrol.

The Defense Ministry declined to comment. The latest defense white paper says that one of the navy's missions is "the capability of nuclear counterattacks."

Despite China's modernization drive, many weaknesses remain in its armory. Chinese military officers' own assessments of their abilities, contained in professional journals and military media, say that they fall short of their goals of being able to fight and win a high-tech local war.

The limits were on painful display during the Sichuan earthquake last May -- a peacetime operation on China's own territory. China mobilized more than 114,000 soldiers to assist in disaster-relief efforts. But given the military's lack of airlift capacity, just a fraction were able to arrive in the quake-hit area by plane in the first day or so after the temblor hit.

The rest had to move by rail or drive. A marine unit spent several days driving from its base in southern Guangdong province. Relief work also highlighted China's serious lack of helicopters.

Dai Xu, a colonel in the Chinese air force, said that the military's earthquake operations showed that patriotism and spirit were unable "to cover up the weaknesses in the army's equipment and technology abilities." Col. Dai, writing in a Chinese foreign-affairs journal, said that "an army without the capability of air mechanization is not qualified to talk about informatization," a reference to high-tech war.

By the Pentagon's own estimates, China's limited ability to move and sustain soldiers beyond its borders hasn't improved appreciably since 2000. The Pentagon also calculates that despite the shopping spree on new equipment, just 20% of the weapons systems used by the Chinese air force are "modern," along with 40% of the navy's submarines and roughly 30% of its surface ships.

Critically, China has no experience in modern war-fighting. The nation's last significant conflict was a 1979 border war with Vietnam. The U.S. military, on the other hand, has been almost constantly involved in conflicts since the start of the Persian Gulf War in 1990.

To make up for its deficiencies, China's military has adopted a strategy of surprise and secrecy to keep U.S. forces off guard. It calls this strategy the "assassin's mace," an allusion to a concealed blade, or bludgeon. In this way, the military believes, its technologically inferior forces can gain the advantage over a technologically superior adversary.

China's stealth fuels U.S. suspicions. The Impeccable interception recalled a similar episode in the area in 2001 when a Chinese fighter plane was in a collision with a U.S. EP-3 spy plane. The U.S. pilot nursed his crippled aircraft to a landing in Hainan, where its crew of 24 was detained for 11 days.

The Chinese plane crashed, killing the pilot. In 2007, China shocked the world by blowing up one of its old weather satellites with a ballistic missile, showering debris into space.

The U.S. Air Force and Navy recently raised the specter of a belligerent China in their calls for more F-22 fighters and long-range bombers, as well as the production of a new, stealthy class of guided-missile destroyer, known as the Zumwalt.

However, this month, U.S. Defense Secretary Robert Gates said he planned to halt further purchases of the F-22 and end the Zumwalt program as part of an overhaul of weapons priorities to reorient the U.S. military towards winning unconventional conflicts such as the war in Afghanistan rather than fighting China, Russia or other major powers.

In China, a vocal public constituency is pressing for a more assertive military. Bai Jieming, who runs a shop in the southern boomtown of Shenzhen selling models of Chinese warships, says that replicas of one of the destroyers sent in December to patrol the Gulf of Aden against pirates, the "168," have sold out. He says that Chinese people long for an aircraft carrier. "I'd even donate money to help build it," says Mr. Bai.

The Impeccable incident has stoked fears about the risks of miscalculation. In 2007, a Chinese submarine surfaced within firing range of the U.S. aircraft carrier Kitty Hawk during maneuvers near the Philippines. The U.S. Pacific commander at the time, Adm. William Fallon, said the incident could have "escalated into something very unforeseen."

Adding to the dangers, says a U.S. Defense Department official, are unclear lines of communication between the Chinese military and other parts of the bureaucracy. Chinese leaders were "surprised, shocked and embarrassed" by the outcry from the U.S. and other countries, such as Russia, after their military shot down the weather satellite, he says.

This could have been avoided if they had gotten better advice from nonmilitary sources. "There's a learning process that goes into being a major power," he says.

China sends conflicting messages about its desire for power and influence in the world. It is the world's third largest economy, and presses for a greater say in international financial institutions to match that status, yet constantly sends reminders that in terms of per capita income it remains a relatively poor developing nation. Large parts of China's military spending, including R&D outlays, do not appear in its official numbers on defense spending.

Past assessments have not seen China as an electronics superpower. China could turn its electronic prowess developing ever-faster computers and high-speed communications equipment for American consumers into cyberweaponry. Even so, it will still be a long time before China is the formidable military might some in the U.S. see.

Source.

In 2007, when globalization was a top buzzword in the venture business, Draper Fisher Jurvetson, a well-known Silicon Valley firm, was busy touting its worldwide network of affiliates.

That year, the firm expanded its network to London, Brazil, Israel and Russia and was looking for partners in Central Europe, Japan and Turkey and to expand further in China and India. Point man for the project was Managing Director Don Wood.

Since then, the world has changed. Venture firms are more concerned about shoring up portfolio companies than announcing new initiatives overseas. In light of the global financial crisis, we asked Mr. Wood how the DFJ network is faring.

How has the global financial meltdown affected DFJ’s network of partners?

When I talk to our partners in Brazil or in China and certainly in India, there is still commercial activity, there are still companies being created. There’s a feeling and awareness that they’re not seeing the same brunt of unemployment and so on to the same extent that we are.

But that having been said, it still has impacted the venture capital industry. I would say that the slowdown the U.S. industry has felt in terms of deal pace in similar in the BRIC countries (Brazil, Russia, India and China), in Europe and in Israel.

We’re seeing activity in all of those countries, new deals being done are off probably by 40% or 50%, as it appears to be in the U.S. So they’re feeling the same effects but they do still have growth and their economics are a bit more robust and have been affected less.

On the fund-raising side, the limited partners in the United States have been hit fairly hard and there seems to be a similar difficulty in fund-raising outside the U.S. But that being said our network funds have actually been raising money. They’re raising funds smaller than they originally envisioned, but they’re still raising money. They’re getting closes now, so we’re very encouraged by that.

How big is the network now?

Right now we have 16 funds that are actively investing. If you look at population coverage, I think we’ve got 75% of the world’s GDP in the regions where we’re currently operating.

What’s the status of expansions plans?

We’re always open to talking to qualified investors in different regions of the world. But we are being very selective and we’re not in any rush to expand the network. There are a few areas where we don’t have coverage in the network and we think it makes sense.

One is Japan. We’re in the process now of creating a DFJ Japan fund. Certainly the Japanese economy and the market has been hit, and venture capital IPOs in Japan have taken a fairly dramatic decline just like in the U.S. But we still recognize it’s the second largest national economy in the world and they have been evolving in the way they do venture capital.

It’s still very local and Japanese centric, the venture investing that goes on there today, but there is recognition that the U.S. model of venture capital is something that they could benefit from.

Are there other areas?

We have explored and met the various venture funds operating in Central and Eastern Europe and are in discussions with several there. We didn’t feel like it was something that needed to happen immediately after understanding the type of investing that’s occurring there and the pace of investing.

We’re often asked, ’What about more investing in Southeast Asia, in Singapore, in Malaysia and what about Africa?’ Those are areas we’re certainly interested in, we’ve visited, we’ve talked to investors. I would put them in the “someday” category. We’re not rushing to do it but we think there’ll be a time when it makes sense to include them in our network.

Have you learned any new lessons about maintaining the network?

We’re always pushing to try to make it stronger. What makes it stronger is when we have better communication among the partners. We’ve got 150 professionals on four continents. There’s an expert within the network on virtually every topic. But how does one person in the fund become aware of all of the activity and knowledge and connections of all of the 149 other people?

That’s the area that we’re trying to work on to figure out how we truly make it a knowledge network that gives every person in the network the full power of the network. We’ve tapped maybe 40% of the potential that we can do. It’s still a very valuable 40% but we’ve got a ways to go.

Source.

There have been many pseudo reserve currencies through the ages. Now, the governor of the People’s Bank of China has called for a new global currency “disconnected from individual nations”.

Russia, too, wants to move away from a world dominated by the dollar. Kazakh president Nursultan Nazarbayev suggests such a currency could be called the acmetal, an amalgam of “acme” and “capital”.

But is there a case for one? In theory, yes. Although no one was banging the table for change when emerging growth rates were still being powered by deliberately undervalued domestic currencies. The reserve currency status of the dollar helped to create nasty global imbalances, one of the main culprits of the current downturn.

As China, for example, recycled export earnings back into dollar-denominated assets, the US could happily run profligate trade deficits with impunity. That helped push up the price of US assets, particularly house prices.

Now surplus countries are stuck. They cannot diversify fast enough and a rapid sell down of US assets would destroy their portfolios. Not only that, global central banks holding about two thirds of their reserves in dollars are hostage to the Obama administration.

Unsurprisingly, huge budget deficits and the Federal Reserve’s leap into quantitative easing have foreigners fretting over the longer term health of the dollar.

Theory is one thing, however. In reality, currencies live and breathe more than just short-term economic air. The two other life forces for a reserve currency are sovereign credibility and power.

China, Russia and India simply do not have long enough economic track records to justify backing a reserve currency. Find a single investor in this crisis that has panicked out of dollars into roubles. Of course, if China one day emerges as the dominant economic and military power, the status quo will change. Until then, investors cannot be rushed.

Source.

The effects of the recession and tightened credit markets have made themselves well known in the United States, but the slowdown is having a profound effect on economies overseas as well. Iain Clark, chief investment officer for Henderson Global Investors, admits it is a tricky time for investors to make stock bets in Europe and Asia.

But the London-based fund manager does have some stock-picking tips to share. It is difficult to judge when any economy will recover from the current downturn, and many have been wrong in the past. But by focusing on companies that aren't beholden to the credit markets and have staying power, investors can wait out the storm, according to Clark.

Below are some excerpts from his interview with Barrons.com about Henderson's International Opportunities Fund (ticker: HFOAX).

Barrons.com: You have investments in Europe and some in Asia as well. How should investors approach these economies, as there are fears they will suffer from a prolonged recession?

Iain Clark: Our strategy is to focus on two things: quality companies with sound balance sheets. When I say sound balance sheets, I don't just mean with lots of cash. Companies can have a bit of debt, but it must be fairly modest and must be longer term because if you have to refinance debt in the next year or two, I think you are still going to have a major problem.

It doesn't necessarily mean traditionally defensive stocks. We don't know how deep this recession might get. It may still get a little bit deeper. But these companies are still going to be around in one year or three years, they seem reasonably safe from that point of view. We are focused on soundly financed [companies that are], generally, the quality end of the spectrum.

Q: Obviously you are taking a company-by-company approach to this. But do you have a larger sense of what economies might bounce back first?

A: It's very difficult to make that judgment right now. Our focus is on individual stocks, and the overall balance of the fund is more from the particular stocks that we own. I am sort of happy with the China story, but elsewhere I think it's very difficult to tell.

The U.K. is an interesting case because the government and the central bank are being a lot more proactive in trying to get out of the recession. But the U.K. probably had a bigger set of problems in the first place. We have quite high debt levels in comparison to Europe and, obviously, we have probably more banking problems than the rest of Europe. So I think it's very difficult to tell in that situation whether we are going to come out of the recession ahead of France or Germany.

Germany is very dependent upon exports. Exports have been heading down very rapidly for the last few months, but the domestic economy is probably sort of OK. Unemployment will start to rise before too long, but not too badly. At the same time [unlike the U.K.], Germany is not really doing much to help the economy, just little bits and pieces here and there.

So while the problems of Europe are not as bad as the U.K., equally the European governments and central banks are doing rather less to try to get out of it. I wouldn't put any bets on who comes out of this first, but my personal view is that the U.K. will be first, it will be a bit more entrepreneurial than the rest of Europe.

Q: You mentioned you were optimistic about China?

A: The situation in China is quite simple except you are dealing with very big numbers. We know that exports are collapsing, and that's quite a large part of the economy. But what we also know is that their authoritarian government is spending huge amounts of money, we say about 6% or 7% of the gross national product, which is bound to have an impact.

Take infrastructure spending in the power-generation area, for example: They already have a six-to-seven-year plan in place, so when they decide that they are going to spend money, they just bring all of that forward. They tell the banks to lend and, within a few days, the money starts flowing and the business starts getting done.

If you are in the U.K. or the U.S., you have to spend three to six months running around the politicians, trying to get support for a large spending package. You have to work out what it is actually going to be spent on. Then the banks have to do a bit of lending, and maybe one to two years later something starts to happen. So there's a huge difference in China in terms of the speed of execution.

They were running a small budget surplus before they went into this [recession], and their total debt as a percentage of GNP is very low compared to a lot of other countries, so they do have the financial firepower to introduce these major measures. Virtually no one else has that sort of combination.

If you look at India, there's no question that they need lots of infrastructure spending. But they don't have the total financial firepower that China has. India is still a democracy, and so they can't just decide to do something.

I am still slightly hesitant because I think China has been quite a popular play already. But the stock market, as you may recall, fell incredibly sharply last year. A stock that we have been happy to add to over the course of this year is China Mobile (CHL). Again, this is not an unknown stock, but it is the No. 1 player by miles in China. We think this company still looks pretty cheap and has plenty of opportunities for growth.

Q: Are there any other companies that you'd like to mention that fit your quality and balance-sheet criteria?

A: Germany's Fresenius Medical Care (FMS) is the biggest player in kidney dialysis; it benefits from the increasing [rates] of diabetes and other illnesses. The medicines and treatments that it produces are more and more needed, it is growing very steadily. It has recently raised some capital in the bond markets. But it is a soundly financed company. It is not really as battered as other companies are by the fact that the economies go up and down, because demand is so constant and growing for its medical products.

Q: Thanks for your time.

Source. Subscribe to Barron's. Henderson's International Opportunities Fund.