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The Raff Report – December 2016

December 3, 2016

Crikey, another year is almost over and it’s time to look ahead for what 2017 might hold. How much the world has changed since the last Raff Report is impossible to measure. Some nights ago the right-wing Austrian party failed to gain parliament but a 54 to 46 score between the two major antagonists was probably closer than many would have preferred and perhaps still a signal of what’s to come as populations world over become sick of namby-pamby governments which includes our own as being a good example.

 

Also, last night, a referendum in Italy to introduce constitutional reform got defeated 54 to 46. Prime Minister Matteo Renzi resigned over the matter. Renzi wanted to reduce the number of people in the upper house from 315 to 100. The main opposition to change came from the Five Star Movement (M5S) that some pundits believe will get swept to power at an election that will follow Renzi pulling up stumps.

 

A problem that might arise is this: the Five Star Movement wins the election and holds a referendum on Italy remaining in the Euro. Such a referendum would come at a tricky time with Italian banks buckling under 360 billion Euros in non-performing loans. The cupboard is bare and Italian banks don’t have the readies to try and grow the economy. Despite massive unemployment, Italian finance minister Pier Carlo Padoan told a G20 meeting in China that Italy did not have a problem with its economy.

 

The Raff advises Mr Padoan that he must be living on another planet because Italy has huge problems. The Raff knows for a fact that in rural Italy (and probably the cities) that many people work for no pay hoping that one day the boss will be able to pay them. Many rural businesses have closed their doors and the feeling is one of absolute despair. One potential solution to Italy’s problems is to go back to the Lira and give support to massive devaluation of its currency.

 

To do this of course would require Italy to quit the Euro, and perhaps the EU as well, something the Five Star Movement would heartily endorse. In Europe, only Greece has a higher debt level. The general view seems to be that Italy leaving the Euro, and then in turn the EU, is a far greater concern than Brexit. If Italy left so too might Greece.

 

The EU has been an experiment in taking sovereignty away from all of its members. The experiment has failed and people are seeking autonomy away from the unelected officials in Brussels. As the Raff sees it, there is probably no turning back nationalism and the movement towards the right-wing to deal with namby-pamby centre and centre-left politics.

 

Coming up in Europe is the General Election in the Netherlands on March 15, 2017. The Dutch right-wing might to better than in Austria. The Dutch Freedom Party is led by Geert Wilders whom is ahead in the polls. Geert’s view includes banning headscarfs completely and that the Dutch shouldn't pay for Angela Merkel allowing Germany to be flooded with refugees from Syria and the flow on effect to other countries.

 

Some pundits believe that France has greater potential to blow-up than Italy. The French are going to the polls on April 23, 2017. Should Front National leader Marine Le Pen win the French Presidential Election she wants a “Frexit” and complete control over French legislation, money, borders and economy and what peoples wouldn't want that? But first Marine Le Pen has to beat the Republicans' Francois Fillion, most likely in the second-round, of the election. French President Francois Hollande has reportedly decided not to seek re-election. Hollande is so widely disliked in France that his chances of re-election are very low.

 

Manuel Valls has thrown in the towel as France’s PM, to fight to become the Socialist candidate and thereafter a Socialist President.  Valls wants the UK to relax its immigration policy to solve the Calais crisis. Valls would like the hordes of immigrants camped at Calais to swarm across the channel to seek a better life – so they think. It’s really a French problem because they allowed the refugees to cross their border in the first place.

 

In Germany Angela Merkel said that she would run for a fourth term with an election to be held in September next year.  The far-right in Germany, Alternative for Deutschland (AfD), led by Frauke Petry, is gaining ground. If the disgraceful events of Christmas and New Year’s Eve 2015 are repeated again, that is the rape and assault of a large number of German women by migrants, then the right-wing should be a shoo in.

 

The truth is that Angela Merkel is solely responsible for a huge change in a short time in the social fabric of many European countries and now it is time for her to pay the piper. Just right now it does not look like anything good is going to come out of Europe in 2017 to please financial markets and in the in between time uncertainty will weigh on European bourses.

 

Economic data

 

We now turn attention to some economic data. The Raff admits to being lazy again by not updating his own databases. It’s much easier generating charts direct from the US Census Bureau, although there are problems with charts with more than five years of historical data. Be that as it may, mentally imposing a 12-month moving average on relevant numbers indicates the likely peak of the durable goods cycle.

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 US Shipments of Durable Goods shows a similar story. This cycle generally peaks in June; orders for June 2016 were down 1.9% on a year ago, and shipments also appear to have peaked.

 

FIGURE 1: Baltic Dry Index. (Source: Investment Tools.com.)

 

 The Baltic Dry Index, a well-known and generally reliable measure of bulk shipping costs seems to have bottomed but is still at an abysmal level. Recent hikes in the prices for coking coal and iron ore have their particular drivers. For coking coal cutback in Chinese production has created a shortage in the market and the price of coking coal soared dragging up the prices of thermal coal. Figure 1 might also indicate that the slump in world trade is bottoming out and that 2017 will be the year of recovery.

 

 

FIGURE 2: CRB Commodity Price Index. (Source: Investment Tools.com.)

 

 

 

Strong recoveries in the prices of iron ore, coal, copper, zinc and some soft commodities has boosted the CRB Commodity price index as shown in Figure 2; it’s not all beer and skittles yet because markets will need contend with below trend global growth in 2017.

 

 

 

 

 

 

 

 

Assuming copper remains a bellwether industrial indicator then things are looking up. LME stocks are trending down and price has shot up.

 

The following table is really interesting because it shows a recent trend in investor sentiment as it relates to the futures markets for commodities. (Source: Investment Tools.com.)

 

Futures 20-DAY % Change at October 27, 2016

 

 

A quick inspection of the table shown here adequately explains the excitement in resource shares again. The futures market is certainly forecasting a strong recovery in world trade during 2017. If this does not eventuate then the prices of resource equities will exhibit a marked correction in 2017.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

The Raff had better not forget China. Using the eye of faith, China’s economy has also bottomed out as shown in Figure 3.

 

FIGURE 3: China’s Industrial Production. (Source: TRADINGECONOMICS.COM.)

 

 

 

In conclusion

 

2017 looks like being another challenging year for investors. Deep political uncertainty in Europe and threat of interest rate hikes in the US are reasons for caution.  The US economy has shown signs of a cyclical high for some time, as illustrated in recent Raff Report and by the latest Durable Production and Shipments data.  Just a bit more on the US: inventory to shipment levels have backed up to 2009 levels and have risen steadily since March 2011. Additionally, the annual rate of construction spending in the US exhibited a massive recovery from US$755 Bn in January 2011 to US$1,173 Bn for October 2016. The previous cycle high was US$1,205Bn for March 2006.

 

As with other important data, the US construction cycle is topping out; unbelievable that the US would raise interest rates now.

 

Comments

 

Thanks for the Christmas Raff Report – I know the Leader of the Dutch Freedom Party Geert Wilders has coined a term for 2017 in Europe (borrowing a term used a few years ago in the Arab World) – and called 2017 the year of the “European Spring”.

 

I guess we’ll see how prescient he is. I think also he is the best chance of any of the insurgents in Europe to get up and to be Prime Minister, rather than Marine Le Pen becoming President – Le Pen’s best chance is if somehow the left unites around a candidate in opposition to Fillon. (30% Left 30% Fillon 30% Le Pen – could be very close if they can actually find a candidate – Valls? Hmmm).

 

A leftist candidate v Le Pen means Fillon’s supporters might drift to Le Pen. Le Pen v Fillon is an almost certain Fillon victory one would feel – probably the best result really because the man speaks sense about – for instance working with Russia to eradicate terrorism/ISIS – same as Donald Trump.

 

It would likely leave Mutti Merkel on her lonesome, but that looks inevitable anyway. As an aside – Germany is hosting the G20 meeting next July – there looks to be a whole bunch of new leaders set to be there – May, Trump, Fillon, Italy?, South Korea, Brazil, Argentina, Merkel will not be amongst just friends in perhaps her last big international outing.

 

The wildcard in all this – the European elections in Netherlands, France, perhaps Italy and particularly Germany is Turkey. Turkey still holds 2-3 million refugees – mainly Syrian, and there has to be a strong chance Erdogan has been waiting for next year to push them all into Europe and get rid of some of his “enemies”. Hollande is already gone, so his only target is Merkel probably. Expect a big refugee push to Europe to begin again in May/June/July – perhaps even in the run-up to the G20 meeting to embarrass Merkel!

All the best and a Merry Christmas! 2017 is certainly going to be an interesting year – in my estimation even more interesting than this year!

 

Julian McCrann - Observer at Large. December 9, 2016.

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