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The Commodities Shakeout, how long will it last?

Compared to the tens of trillions of dollars invested in global bonds and stocks, it's still the $80 billion invested in commodity funds that is getting most of the attention these days. The direction of commodity markets, particularly for crude oil, copper, and gold is setting inflation expectations in the global bond markets, and clueing central bankers for their next moves on interest rates.

The latest 20% plunge in the kingpin crude oil market to below $60 per barrel, has whacked commodity fund investors, but has been a blessing for most stock markets included in the Morgan Stanley World Index. On the other hand, the resource heavy Australian and Toronto Stock Exchange, and emerging stock markets in Brazil, Russia, and South Africa, would be at risk from a prolonged slide in commodities.

Commodity currencies, such as the Australian and the South African rand, which have strong ties to base metals and gold, are under selling pressure, and the Canadian Petro-dollar is losing its luster, due to sharply lower oil prices. Gold and silver have been held hostage to crude oil, and many traders are wondering whether the latest plunge in oil is linked to US election politics.

But with the Reuters Commodity Index (CRB) flirting with the psychological 300-level, led by crude oil, copper, and gold, the big unresolved questions are (1) whether the sharp drop in commodities is heralding the onset of a major global economic downturn, led by the US housing market, or (2) maybe just a speculative shakeout, and if so, (3) how long will the latest shake-out in commodities last?

(Click on link below to hear an October 6th interview with Mr. Dorsch, who answers questions on the global economy, gold, crude oil, interest rates, stock markets, and foreign currencies).


Until recently, the Reuters Commodity Index was tracking the MSCI World Index for the previous four years, led by a 5% growth rate for the global economy, and surging demand for raw materials in China and India. Commodities typically rise when global growth and consumption are strong and decline when the world economy sinks. If so, the recent plunge in commodities might suggest the global economy is in for some rough sledding in the months ahead.

Global Capital Markets Celebrate Lower Oil prices

However, stock markets in major oil importing nations, such as Germany and the US, are singing a happy tune, celebrating the latest 20% energy tax cut. The sharp decline in crude oil prices from $75 to $60 per barrel, if sustained, would cut the US oil import bill by roughly $4 billion per month and the German import bill by $1 billion /month. German and US bond yields have also dropped by 40 to 60 basis points since mid-July, as inflation pressures receded due to sharply lower oil prices.

The latest plunge in the Reuters CRB Index also highlights the wizardry of central bankers over global markets, when they act in lockstep for a common goal. By tweaking their short-term rates higher, central bankers from a dozen different countries, succeeded in frightening commodity speculators, but lifted the spirits of bond and stock market traders. The debate in the US bond market has now shifted to when the Federal Reserve will start lowering the fed funds rate.

The recent slide in crude oil prices to 7,000 yen per barrel has eased inflation fears in the Japanese bond market (JGB's), knocking the 10-year yield from 2.00% in mid-July to as low as 1.62% last week. The Bank of Japan has ended its radical policy of "quantitative easing" (pegging interest rates at zero percent, and flooding banks with an excess of 26 trillion yen), and helped to wipe out some of the speculative froth in international oil prices, through the partial unwinding of "yen carry" trades.

However, Japan's new prime-minister, Shinzo Abe is opposed to further BOJ tightening moves, which would push JGB yields upwards towards 2.00 percent. "Increases in interest rates would have a big effect on the government's debt interest payments. We have to keep a close watch on their moves." Japan had 765 trillion yen in sovereign marketable securities, or $6.5 trillion, outstanding at the end of June, compared with $4.3 trillion in the US Treasury market.

The latest 0.3% drop in 10-year JGB yields lowers Tokyo's debt-servicing costs by 480 billion yen ($4.1 billion). The latest 20% drop in world oil prices also reduces Japan's oil import bill by $1.9 billion per month. However, Japanese banks, which own 140.4 trillion yen ($1.24 trillion) of JGB's, roughly the size of Canada's economy, might want to unload JGB's, if crude oil holds support at 7,000 yen /barrel, and rallies higher after OPEC lowers oil output.

The Evaporation of the Iranian "war premium"

In retrospect, but the plunge in crude oil from $75 per barrel to $60 /barrel, is linked to the evaporation of a $15 per barrel Iranian "war premium," that was built into prices earlier this year. The energy sector, including crude oil, unleaded gasoline, heating oil, and natural gas, accounts for 39% of weighting within the Reuters CRB index. Thus the post August 8th plunge in the CRB index is probably a speculative blow-out of over extended long positions in crude oil, base and precious metals.

The majority of oil traders now think the Bush administration is just a "paper tiger", and has discarded the military option against Iran. Instead, mired with a 37% approval rating, President George Bush appears resigned to a protracted diplomatic process with Tehran, and dabbling with cosmetic sanctions that have little potency. So without the credible threat of a US military attack on Iran, energy prices began to feel the gravitational pull of hefty US energy stockpiles.

US crude oil inventories rose to 8-year highs of 346.7 million barrels in April 2006, yet crude oil prices continued to climb towards $80 per barrel. US oil companies were hoarding oil, worried about supply interruptions from unstable places, such as Iraq, Iran, Nigeria, and Hugo Chavez's Petroleos de Venezuela. Yet the last time US oil stockpiles were as high as 346.7 million barrels, the price of crude oil was trading between $15 and $20 per barrel in 1998.

Recently, Iran has been in secret talks with European Union foreign policy chief Javier Solana, attempting to split the EU from Washington's drive for economic sanctions. But on Oct 4th, Solana indicated that Tehran had not agreed to halt its enrichment of uranium, despite four months of discussions. "If anyone thinks talks can be used to pressure us they are wrong," declared Iranian president Mahmoud Ahmadinejad on Oct 4th. "The Iranian nation, in its path to obtain nuclear technology, will not be stopped even for a second. Nuclear technology is our obvious right."

Iran has sewn up the Chinese and Russian vetoes at the United Nations, leaving US diplomacy at a dead-end. Iran may give China and Russia access to its giant Azadegan oilfield, which contains 26 billion barrels of proven oil reserves, and 6 billion of probable reserves, in return for blocking UN sanctions over its nuclear weapons program. France's Total Fina hopes to secure a small stake of about 15% in Azadegan, after French president Chirac spoke out against UN sanctions.

In a blow to Tokyo's hopes for enhanced energy security, oil company Inpex revealed on Oct 6th, that Japan's stake in the Azadegan field had been cut to 10% from the 75% share agreed in February 2004. Japan expected to pump about 260,000 bpd from Azadegan, equal to just over 5% of its imports. Azadegan was to have been the jewel in Japan's overseas oil holdings, helping it keep up with China and India's aggressive state-owned companies, now scouring the globe for energy resources to feed their fast-growing economies.

Talks between Iran and China's Sinopec 0386.HK, in developing the Yadavaran oilfield, are expected to be completed in two months, said deputy Iranian Oil Minister Mohammad Hadi Nejad Hosseinian on Sept 26th. Yadavaran has estimated reserves of about 3 billion barrels and is expected to produce 300,000 bpd, roughly the same volume of crude that China now imports from Iran.

Testing the Resolve of the OPEC Cartel

On Sept 22nd, Saudi oil chief Ali al-Naimi tried to stabilize oil prices at $60 per barrel, with verbal jawboning which sparked a brief bounce to $64 per barrel. "Prices now are rewarding to both producers and consumers and their impact on the global economy is small. The most important gauge for this price is that it does not have a big negative impact on the global economy," said Naimi. But the rebound was short-lived, and oil prices were again sliding under $60 per barrel a few days later.

Then on Oct 3rd, OPEC President Edmund Daukoru called for output cutbacks, after US oil prices tumbled below $59 a barrel, their steepest drop in oil prices in 15-years. Nigeria and Venezuela withdrew a combined 170,000 bpd from their production from Oct 1st, but the cuts represented less than 1% of OPEC-11's daily supply. Instead of restoring stability, Nigeria and Venezuela only succeeded in communicating to the market that they were worried about a supply glut.

But on October 4th, Kuwaiti Oil Minister Sheikh Ali al-Jarrah al-Sabah indicated the oil kingdom might join Nigeria, Iran and Venezuela in cutting its oil output if prices continue their steep drop below $60 per barrel. "Kuwait may voluntarily lower oil output in order to maintain the market's stability. We are currently in negotiations with fellow OPEC members. The current situation with prices and the big retreat that has taken place is uncomfortable for OPEC nations," al-Sabah added.

The Kuwaiti oil minister said "$60 per barrel for US light crude is a comfortable price, but $50 /bl is worrying." On October 8th, following an extra ordinary telephone conference, OPEC agreed to a deal to remove 1 million barrels a day of crude from oversupplied markets, as ministers lined up to support the cut. Iran and Algeria publicly backed the reduction, OPEC's first since December of 2004.

"I think there is more or less consensus for 1 million bpd," said OPEC President Edmund Daukoru. "The reference point is the official 28 million bpd ceiling." Algerian Energy and Mines Minister Chakib Khelil said there was consensus to lower output. "This would have a positive impact on the market. What is important is that the market finds the OPEC position credible. That is why it is necessary to have a meeting to make a decision on the cut and to act on it," Khelil said.

Election Politics and Crude Oil

It is interesting to note, the last time OPEC cut its oil output in a meaningful way in December 2004, was to defend US oil prices from falling under $40 per barrel. Today, OPEC seeks to stabilize crude oil prices at $60 per barrel. Despite the 50% increase in oil prices since October 2004, the Dow Jones Industrials is 20% higher. OPEC knows the world economy can expand at $65 to $75 per barrel, so the cartel doesn't see any reason why prices should fall too much further.

Do oil prices and election politics go hand in hand? In the last run-up to US elections in 2004, a surge in crude oil prices from $44 per barrel on Sept 16th 2004, to as high as $55.25 on October 26th 2004, had knocked the Dow Jones Industrials 500 points lower to the 9750-level, and according to CNN polling data, President Bush's 7% lead over John Kerry soon swung into a 3% deficit.

For much of 2004, gyrations in the stock market revolved around polling data. When Kerry pulled ahead of Bush, the stock market turned lower, and vice versa. When the Dow Jones Industrials fell below the psychological 10,000 level to as low as 9750 in October 2004, with only 7-days left before Election Day, the Kerry camp was jubilant, since Wall Street pros were apparently pricing in a Bush defeat.

But fortunately for Bush, the price of crude oil did a 180 degree reversal, and tumbled 10% to $49.50 /barrel in the final week before the elections. The Dow Industrials rebounded above the 10,000-level, viewed by pollsters as Wall Street's red line between a Bush or Kerry victory. The last minute drop in crude oil, combined with a Dow rally, might have helped Bush to a 51% to 48% popular vote victory.

Republicans trying to hold onto their seats on November 7th are also hoping for a bit of good luck. Will a 70 US-cent per gallon drop in gasoline prices, and Friday's report of a 4.6% US jobless rate, the lowest in 5-years, do the trick in 2006?

Gold market held Hostage to Crude Oil

Since peaking at $675 per ounce on July 14th, three rally attempts by gold bugs have fizzled out, and were ultimately wiped out by sliding oil prices. On October 3rd, gold briefly fell below $570 per ounce, after crude oil tumbled below $60 per barrel. Gold was also spooked by fears that European central bankers would dump 180 tons of gold from mid-July until Sept 26th, to meet their full quota of 500 tons per year.

Instead, the European central banks limited their sales of gold to 73 tons on the spot market in the final two months, for a grand total of 393 tons, falling short of their full quota for the first time since 1999. But the London Telegraph published an October 7th reporting that the Bank of France sold up to 100 tons of gold through forward contracts in September, knocking the yellow metal below $600 per ounce.

Also, Amaranth Advisors, a hedge fund manager lost billions of dollars in energy trades in the summer, and was liquidating its remaining positions at fire-sale prices. Amaranth estimated its net asset value declined by 65% to 70% during September, after suffering a $6 billion loss in wrong-way bets on natural gas derivatives, including $560 million in one day alone. Aramanth's dumping of energy contracts indirectly contributed to gold's slide towards its June lows.

At the moment, the gold market is hovering above $570 per ounce, supported by signals that OPEC intends to cut its daily oil output to defend the US crude oil price at $60 per barrel. Gold's initial reaction to Pyongyang's detonation of a nuclear bomb was muted, gaining just $3 /oz in New York, after trading $10 /oz higher in Asia. Nowadays, geo-political tension only seems to benefit gold, when it involves a major oil producer, such as Iran, and impacts the price of crude oil.

Pyongyang Detonates the Bomb, Jolts Korea and Japan

Three years of six-party talks with Pyongyang, simply led to North Korea's detonation of a nuclear bomb on October 9th, 2006. It's no secret that North Korea has a small arsenal of nuclear weapons, but it was a bit of a surprise to see Kim Jong-il pull the trigger. China has been North Korea's main supporter, since its army saved it from defeat by US forces under a UN flag in the 1950's. Beijing provides 90% of N Korea's oil supply, estimated at one million tons per year.

But this time, China might have overplayed the North Korean card. The specter of an Asian atomic arms race now looms over the region, and Beijing could find itself surrounded by neighbors in Japan, South Korea, and Taiwan moving to join the elite club of nuclear powers. Japanese prime-minister Shinzo Abe, a staunch North Korea critic, wants to amend the Constitution to give Japan's military greater leeway to go nuclear, and it won't take long to convert its huge stockpile of plutonium.

Similarly, 3-years of negotiations between the big-3 European powers and Iran have only brought Tehran much closer to obtaining the technological knowledge to build a nuclear bomb. It is certainly possible that Pyongyang would share its nuclear know-how with Iran, in return for a sizeable financial reward. While Iran has only started to produce fissile material, North Korea has done so for at least five years. The next nuclear weapons test could be conducted by Iran.

But traders in South Korean stocks and the won have prospered under the dark shadow from the North, since Pyongyang first disclosed its nuclear arsenal to the world in April 2003. The Korean Kospi index has more than doubled from 3-½ years ago, while the US dollar has plunged by 250-won, or 20%, during the same time period. In the past, sell-offs ignited by worrisome news from Pyongyang, were simply new buying opportunities for foreign and local investors.

At its peak, foreign investors owned 43% of outstanding shares on the Korean Stock Exchange. But foreign investors' sold a record 9.3 trillion won of Korean stocks between May 1st and August 16th, to own just 38% of the market's capitalization. Domestic individuals and institutions filled the void, but after October 9th, local money might be the only hope for the optimist in the Korean stock market.

Not surprisingly, Kospi blue chips and the Korean won, were shaken by Pyongyang's detonation of the nuclear bomb. The benchmark Kospi Index lost 2.6% to the 1,316-level, after falling as much as 3.6% earlier. The US dollar jumped 15-Korean won to close at 964-won in Seoul, partly in reaction the dollar's Friday advance of 1.15-yen to 119.15-yen. Japan and Korea are fierce competitors in global markets, and currency traders in the Korean won track the Japanese yen.

While North Korean blow-ups have usually ended up as a chance to buy South Korean shares at a cheaper price. Behind the scenes, the Bank of Korea inflated the M2 money supply at a 9.3% annualized clip in August, marking the fastest gain in nearly 3-½ years, helping to buoy local stocks and counter US dollar weakness against the won. The BoK is expected to leave its 4.50% loan rate unchanged on October 12th, to soothe jittery markets.

All Eyes on US Economy and Housing Sector

Despite the euphoria of a new record high for the Dow Jones Industrials, the US economy, which accounts for 28% of global economic output, is at risk from a weaker housing market. The pace of existing US home sales fell for a fifth straight month in August, hitting a 6.3 million unit annual rate. US home prices fell to $225,000 in August, or 1.7% lower from a year earlier, and the first annual decline since April 1995. The inventory of existing homes for sale rose 1.5% to 3.92 million units, or a 7.5 months supply, a 13-year high.

A year ago, homeowners were enjoying double-digit price gains and were tapping voraciously into their home equity to finance spending. In 2005, refinancing and cash outs against home equity totaled $550 billion, and exceeded the US after-tax gains in wages of 375 billion. Any back-to-back decline in home prices of more than two months would be unprecedented in the US, and could indicate a deep slump in the housing market and consumer spending that could take several quarters to play out.

"I would estimate that slowing housing construction will probably take about a percentage point off growth in the second half of this year and probably something going into next year as well," said Fed chief Ben Bernanke on October 6th. But the Fed is not expected to cut rates in the fourth quarter to support home prices. "The inflation rate is still above what we would consider price stability," Bernanke added.

"The housing sector is going through a painful, but necessary, adjustment and has slowed overall growth somewhat," said Philly Fed chief Charles Plosser on October 5th. "But the expansion is still on firm footing and growth is likely to accelerate in 2007. We need to remain vigilant and recognize that maintaining the current stance of policy, or even firming further, may be in the best interests of the economy's long-run performance," said super-hawk Plosser. "The predominant risks facing the economy now are on the inflation side."

Fed vice-chief Donald Kohn backed Plosser's views on October 6th, "To date, there is little evidence that this correction in the housing market has any significant adverse spillover effects on other parts of the economy. Resources freed up in the residential market appear to have been largely absorbed in nonresidential building. Lower oil prices should also bolster spending and offset spillover effects from the housing market," Kohn said.

"As the inventory overhangs in residential housing and automobiles are worked off, economic growth should pick up again to a rate closer to the growth rate of its potential. In the current circumstances, the upside risks to inflation are of greater concern," citing rising labor costs, which grew at a annualized 7.7% rate in the second quarter," a hawkish sounding Kohn warned.

But the recent slide in US home prices is leaving Americans feeling a little less wealthy, and in turn, is limiting consumer spending and dragging on growth. The ISM index of the US service sector fell to 52.9 in September, the lowest since April 2003, from 57 in August. Readings below 50 indicate a contraction in industries that account for almost 90% of US gross domestic product.

In the past, the ISM service sector index acted as a good leading indicator for the S&P 500 index, but that wasn't the case in the third quarter of 2006, when US blue chips climbed a wall of worry. The US stock market is thriving in a goldilocks environment, where bad economic news translates into ideas of Fed rate cuts, and corporate buybacks of outstanding shares injects more cash into the market.

From 2001 thru 2004, housing and related sectors accounted for more than 40% of US private-sector payroll growth. But since Fed rate hikes began to undermine home builders in late 2005, the housing and related sectors account for less than 15% of private-sector payroll growth. That has been an ominous trend for the US economy. As housing has tapered off, new-job creation has shrunk.

The US economy created just 51,000 jobs in September, but Labor department apparatchniks jigged the August figures upward to show a 188,000 gain, or 50% higher than originally reported. The jobless rate fell to 4.6%, matching a five-year low. And in another shocker, the Labor Department said payrolls for the 12 months ended in March 2006 will be revised higher by 810,000, the biggest revision since 1991. Currently, figures show 1.8 million jobs were added during that time.

Still, the technical picture for the US jobs market looks bearish, and might be headed for net job losses, (after the November 7th Congressional elections).

China's Economy is linked to the US housing market

China's economy expanded at annual rates of about 10% between 2002 and 2005, a period corresponding with booming Chinese exports to the US, and turned China's economy into the fourth-largest in the world by the end of 2005. But if the US housing oversupply is met by a too-tight Fed in 2007, it could weaken US demand for Chinese imports, and submerge Chinese economic growth into single-digits.

Beijing has relied on exports, primarily to US consumers, to drive its double-digit economic growth. Between 2001 and 2005, China's average annual rate of export growth was 25%. Exports grew by 35% in 2004 and 28% in 2005. Including goods re-exported from Hong Kong, exports to the US accounted for 50% of total Chinese exports. Thus, Chinese export growth is largely determined by US demand.

Exports accounted for 40% of China's economic growth in 2005. And because almost all of China's exports are consumer goods, external demand also plays a key role in the growth of foreign investment in China. Foreigners invested $73 billion in new factories and other investments in China over the past 12-months, and the global economic outlook could impact up to 65% of decisions for new expenditures.

Thus, a US economic downturn in 2007, could have a strong negative impact on China's economy, and rattle other Asian exporters in Australia, Japan, and South Korea. The chain reaction of a US economic downturn could also be felt worldwide, when one considers that 20% of European exports are earmarked for the US, and China's sales of 86.9 billion Euros in the first six months made it the #2 exporter to Europe, just under the US's 89.8 billion Euros.

No Early Signs of a Chinese Economic Slowdown

Yet despite recent monetary moves by Beijing to rein in its M2 yuan money supply, there are scant signs of a slowdown in China's booming economy or stock markets. China's purchasing managers' index rose sharply to 57.0 in September, compared with 53.1 in August, signaling accelerating in growth in the manufacturing sector. The backlog of new orders was 10% higher in September from July.

Mainland China's exports rose to a record $90.77 billion in August, up 32.8% from a year earlier, helping the Hang Seng China Enterprises Index, which tracks 37 mainland companies, to close at 7128 on October 6th. Hong Kong stocks closed at fresh six-year peaks on October 5th, fuelled by a record high in the Dow Jones industrials, and global bellwether HSBC Holdings #5.HK, hit an all-time high.

Hong Kong purchasing managers' index (PMI) also rose to 53.7 in September, the highest reading since May, from 51.6 in August, and marked the 21st straight month of expansion. Exporters stepped up hiring to cope with new orders from mainland China. Global demand for high-technology products made and assembled in Asia, helped Hong Kong's key re-export trade. Almost 95% of Hong Kong's exports are re-exports of goods made elsewhere, often in mainland China.

Shortly after the Hong Kong Monetary Authority matched the Fed's last rate hike on June 29th, by lifting its base rate 0.25% to 6.75%, Hong Kong's 10-year bond yield fell sharply from 4.98% to as low as 3.89% on Sept 26th. The sharp decline in HK 10-year yields produced an inverted yield curve, with 10-year yields falling to as low as 40 basis points below Hong Kong's one-year Libor rate.

The Hong Kong Monetary Authority generally follows in lockstep any interest rate adjustments by the Fed, to keep the HK$ stable at 7.8 per US dollar. Local bond traders are pricing in HKMA rate cuts to follow similar Fed rate cuts in early 2007. However, Hong Kong's three biggest banks, Hong Kong & Shanghai Banking, Hang Seng Bank #11.HK, and Bank of China Holdings, #2388.HK left their prime lending rate at 8.00% last month. The Hong Kong banking system is flooded with local-currency funds, which are driving inter-bank Libor rates sharply lower, giving HK banks wider margins from commercial lending, and boosting their share value.

The flood of liquidity pushed Hong Kong Libor rates to 4.22% last week, or 1% below comparable US$ Libor rates, the deepest discounted yield in 13-years. This situation has arisen because mainland Chinese companies have not repatriated the proceeds from major stock offerings launched in Hong Kong. Meanwhile, Chinese households, who have stashed away some $2 trillion in deposits, are snapping up local bank stocks, viewed as a proxy for the country's 10% economic growth.

Beijing has been staging a series of progressively larger initial public offerings for its big-Four banks, favouring Hong Kong for IPO's of its state-run businesses. The Bank of China launched an $11.2-billion offering in June, and China Merchants Bank, a smaller player, listed its $2.4-billion IPO last month. On Oct 27th, the Industrial & Commercial Bank of China launches a $19 to $21 billion IPO of its shares, beating the previous record set by Japan's NTT DoCoMo in 1998.

ICBC is the largest bank in the world's most populated country, with $815-billion in assets spread among 18,000 branches. Last year, bank lending in China increased 9.7%, and was up another 10.4% in the first half of 2006 alone. Kuwait's Investment Authority is bidding for $720 million worth of IBCB shares while Qatar Investment Authority is targeting a stake worth $205.5 million.

The Canadian Petro-dollar and Toronto blue-chips

Soaring base metals and energy prices have been key factors in the Canadian dollar's 40% rise against the US dollar in the past four years. Nearly 54% of Canada's exports are made-up of commodities, which account for 12% of its C$1.09 trillion economy, the eighth largest in the world. Canada's oil sands in Alberta contain about 174 billion barrels of oil, the largest crude deposits outside the Middle East, and have attracted large sums of investment capital from abroad, boosting the Canadian petro-dollar towards the psychological 90 US-cents level.

Cross-border mergers and takeovers were a big part of the Canadian dollar's strength this year. In the first half of 2006 there were 360 cross-border transactions totaling C$80.2 billion, up from 222 transactions worth C$43.3 billion in the first half of 2005. Sharply lower base metal, gold, and oil prices since August 8th, have stymied the Canadian dollar's 4-year rally, but the Loonie has yet to fully adjust.

Canadian exports have been a key driver behind the performance of the Toronto Stock Exchange. The Loonie's resiliency near 90 US-cents could drag on Canada's economy and result in a loss of export market share in the US, which buys 85% of Canadian exports. Canada's non-energy trade balance has been in a deficit position for the past four months, while its auto trade skidded to a record deficit in July.

Yet Bank of Canada Deputy Governor Paul Jenkins said a cooling US economy, led by a downturn in the housing market, is being offset by an upturn elsewhere in the world, and that will help Canada weather the storm. "The rates of growth in the US were unsustainable, but even with the slowing in the US growth, what we are seeing is stronger growth in the rest of the world. For Canada, you've got to do that global add-up, you can't look at just what's happening in the United States," he argued.

South African Rand at 3-½ year Low, as metals Tumble

South Africa's rand plunged to a 3-½ year low of 7.86 versus the US dollar on Oct 3rd, has slumped by about 22% on a trade-weighted basis since the start of 2006, knocked lowered by falling gold and platinum prices, and negative sentiment towards South Africa's gaping current account deficit. South Africa is the world's largest gold and platinum producer and the rand often moves in step with the precious metal. The correlation between gold and the rand was 81% this past year.

The Reserve Bank of South Africa (RBSA) has already lifted its repo rate by 1% to 8% since June to stem the rand's decline, but the rand remains on a slippery downward slope, and a further RBSA half-point rate hike to 8.50% at the next policy meeting on October 11th appears inevitable. The possibility of a one-percent rate hike exists, or the bank could signal another 0.50% rate hike for December.

On Sept 14th, RBSA chief Mboweni, gave currency traders the green light to hammer the rand, as a quick fix to correct South Africa's gaping current account deficit. "The deficit we are seeing on the current account balance of payments is partly the result of a rand exchange rate that might have been out of balance. I think that exchange rate is now adjusting to the realities." Mboweni's comments knocked the rand below 13.50 US-cents towards 12.8 US-cents, over the next three weeks.

The exchange rate is "the quickest mechanism for rebalancing of external imbalances, and the rate also done so in an orderly fashion, which is what everyone wants, an orderly adjustment of imbalances," Mboweni said on Oct 2nd. South Africa's trade balance is in deficit of -6.1% of gross domestic product, or twice the rule-of-thumb acceptable level of 3 percent.

But the devaluation of the rand has sent South African producer prices sharply higher. The PPI rose 1.5% from July to August, or 9.2% YoY, the highest since December 2002, and far above 8.1% in July. Mboweni indicated that if the large shortfall on the current account persisted for a long time, it would lead to a weaker rand, fanning imported price pressures and force interest rates higher.

Mboweni said the high levels of credit extension had led to record household debt of almost 70% of disposable income. "The high levels of consumer expenditure have also contributed to the expanding deficit on the current account of the balance of payments. These developments pose a threat to the inflation outlook," Mboweni warned, sending an explicit signal of an RBSA rate hike for Oct 11th.

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