By The Gold Report, on February 17th, 2011
The Cordillera del Condor region, located on the contentious Ecuador-Peru border, has proven to be rife with precious metals and political risk. In this exclusive interview with The Gold Report, Geologist Bob Casaceli delves deep beneath the earth’s crust to explain why this dynamic region’s formation points to further discoveries in the area.
The Gold Report: Bob, it seems like everyone knows you. How did you get your start in this business?
Bob Casaceli: I first became interested in geology through mountain climbing, which was an offshoot of my ski-racing career at the University of Colorado. My ski teammates would take me to areas to learn technical rock climbing, and I would study the geology of those areas.
I was always intrigued by the Andes. In graduate school, I was very interested in the mineralogy, tectonic origins and lithochemistry of the ore deposits. I studied isotope geochemistry as a methodology of determining the origin of ore deposits and was able to get some consulting work in Mexico, Central America and throughout the Andean region. I worked with some partners who were former colleagues at the Anaconda Copper Company and formed a consulting company called Annapurna Exploration. It was a great springboard to understanding the systems of gold, copper and silver mineralization in the Andes.
TGR: Didn’t you later do some geology work with royalty company Franco-Nevada Corp. (TSX:FNV)?
BC: In the 1990s, I was president and chief operating officer of L.A. Nevada, which was the Latin American subsidiary of Franco’s sister company, Euro-Nevada Mining Corp., which is a subsidiary of Newmont Mining Corp. (NYSE:NEM). My job was to look for royalty opportunities throughout Latin America. I covered the ground quite thoroughly then and worked in every Latin American country. Later, beginning in 2008, I worked with the new Franco-Nevada U.S. Corporation as its chief geologist.
TGR: Did you ever visit Aurelian Resources Inc.’s (TSX:ARU) Fruta del Norte deposit in Ecuador?
BC: I crossed over what’s now part of the property when I was working in the area with my consulting company. We were working in the Nambija and Chinapintza Districts and covered that area when it was even more remote than it is now. I haven’t seen it since the recent development.
TGR: It’s been about two-and-a-half years since Kinross Gold Corp. (TSX:K; NYSE:KGC) paid roughly $1 billion for Aurelian and the Fruta del Norte gold deposit. Could you tell our readers about the region and why it’s highly prospective for high-grade gold deposits?
BC: The primary reason is that it sits atop the main subduction zone of the Andes. A subduction zone is where the oceanic plates from the eastern Pacific Plate are pushed underneath the South American continent and melted. Magmas are generated, which rise and melt the lower crust.
Based on the work I did with isotope geochemistry in graduate school, it appears that the majority of the metals in the melts actually come from the lower crust with a lesser contribution from the mantle. They’re incorporated by the magmas rising above the subduction zone and spending what’s called “residence time” to allow for more melting of the lower crust and further incorporation of the metals that are contained therein. The magmas come up to the surface through fractures in the upper crust and are expressed as volcanoes. They formed a range along the continental margin in the Late Jurassic period about 150 million years ago in the area of Fruta del Norte. The continental margin was evolving from what’s called an “island arc,” where volcanoes are separated into distinct islands and later compressed to form the continental mass we see now—the high Andes, lower coastal ranges and the coast itself.
The magmas, or molten rocks, form the volcanoes—usually stratovolcanoes—for the most part, which are the tall, cone-shaped volcanoes. Subsequent to the formation of the stratovolcanoes, there is time for gases and waters to mix with metals, which partition off into a fluid phase. That fluid phase is the source of the metal deposits. A subduction zone that’s active for many millions of years has a lot of time to generate metal-rich hydrothermal deposits. They deposit upon and enrich each other. That’s the main reason there are many deposits along the South American Cordillera mountain ranges.
There are cross-structures that create open spaces and better intersections that are more permeable. There is oblique subduction, which occurs when a subduction slab doesn’t meet the continental margin at 90 degrees, but rather meets it at an angle and creates what’s called “strike-slip faulting” as a result. That strike-slip faulting causes the rocks to move horizontally past each other and jump in their movement. When they jump, they create these small areas of extension within the jump—or jog—and that creates the open space. Any time there’s open space created above a magmatic source, such as a subduction zone, it facilitates the creation of ore deposits at the surface along the open spaces.
TGR: The biggest gold deposit found to date in that area is Fruta del Norte, which is close to 14 million ounces (Moz.) of high-grade gold. That was the biggest story in the mining industry for years. Something like that would usually spawn a staking rush, but that didn’t happen. Why?
BC: Political reasons, but that’s my bias. The president of Ecuador, Rafael Correa Delgado, has said he is dedicated to nationalizing certain industries, including the mining industry. The reality is that Correa is of the political persuasion that minerals are a part of the realm of the state, but more than just simply through royalty ownership or payments. He has made statements that he would consider nationalizing oil, gas and mining. That definitely put fear into exploration companies and kept many out.
TGR: What role do the indigenous tribes play in keeping development at bay?
BC: Aboriginal people are concerned about the exploitation of their ancestral lands. That’s certainly true in the Amazonas region of northern and northeastern Peru, which borders Fruta del Norte. This movement has been exacerbated by support from Venezuelan President Hugo Chavez and his supporters. I believe that it’s become a more difficult situation because of Hugo Chavez’s financial support, but I have no direct evidence of that—I’ve only heard rumors. The movement has received other support; for example, a leader of the aboriginal movement in Peru was given protection in an embassy in Nicaragua to avoid his capture.
TGR: It’s taken a little while, but some companies are coming to the Fruta del Norte area and exploring again, especially on the Peruvian side of the border with Ecuador. Could you tell us about some of those companies and what they’re doing?
BC: The largest, most obvious one is Newmont Mining Corp., which has been active in that area. However, I believe the company that’s had the best success is Dorato Resources Inc. (TSX.V:DRI; Fkft:DO5). It owns options on claims that are directly on the border, about 25 kilometers to the south of Fruta del Norte and directly across from Chinapintza and Santa Barbara, which are known areas of excellent gold mineralization.
TGR: Dorato has a few targets it’s working on. One of the more promising ones is the Lucero target, where some drilling intersected copper/gold mineralization, including roughly 30 meters averaging 2.85 grams per ton (g/t) gold and 0.37% copper. Could that be a copper-gold porphyry deposit?
BC: I think it is; it has all the earmarks of a copper-gold porphyry deposit from the chemistry that’s exhibited by the mineralogy and alteration at the surface and in the drill holes.
TGR: Those types of deposits are favorable because they could be of interest to major gold and copper producers. Given the political issues in the area, this would have to be a substantial target in order for companies to be willing to get it off the ground.
BC: True, but Dorato’s properties are on the Peruvian side of the border. It’s right on the border, but it’s still Peru. I’ve worked there for many years and have a high regard for the Peruvian people and their support of mining. It is a mining-mentality nation, though there have been some inconsistencies over the years. Recently, legislation was proposed to double the royalties from a 1%–3% range to a 2%–6% range, as well as to put up to a 10% gross sales revenue royalty on gold and 5% on copper.
Nevertheless, Peru is firmly a mining country. I’ve seen many properties develop there. Newmont has made great profits on its mining efforts in northern Peru. The country is a more secure investment than Ecuador. I’m very skeptical of Correa’s administration.
There are, however, other discoveries on the Ecuadorian side, such as the former Corriente Resources Inc.’s Mirador copper-gold porphyry deposit [now owned by Tongling Nonferrous Metals Group Holdings Co. Ltd. (SZSE:000630)] and Dynasty Metals & Mining Inc.’s (TSX:DMM) Jerusalem deposit.
TGR: Do you think Dorato’s Lucero target has the potential to reach the size of Exeter Resource Corp.’s (TSX:XRC; NYSE.A:XRA; Fkft:EXB) Caspiche copper-gold porphyry project in Chile?
BC: Caspiche is a very special area. I had the opportunity to work on the property in the very early days—well before Exeter got there. I’ve followed the work that Yale Simpson has done as executive chairman of Exeter. The company has done a great job. That’s a huge system in a belt of other very large systems. Lucero is the same type of deposit, but I don’t see anything yet that clearly makes Lucero the magnitude of Caspiche. Nevertheless, I have little doubt in my mind that it will be a mine. I don’t know yet if it has the potential to be the size of Caspiche, because that would be tens of millions of ounces of gold.
TGR: You did some due diligence on these projects on behalf of Franco-Nevada, which now has a royalty on the property that’s being optioned by Dorato. How long ago was that and what exactly did you do?
BC: The first deal was a private placement investment in 2008 with an option to purchase a royalty in the future, which hasn’t yet been exercised. In 2009, a second private placement investment expanded the area over which Franco-Nevada’s royalty option would apply. I worked on the second royalty option deal.
TGR: Was Franco-Nevada more interested in Taricori, Lucero or both?
BC: It was initially interested in Taricori because the hope was that it would fit a Fruta del Norte model. It doesn’t, exactly. Fruta del Norte is an intermediate-sulfidation epithermal deposit of Late Jurassic age and Taricori is considerably younger and formed in a sub-epithermal environment.
TGR: It’s in the pull apart basin, correct?
BC: Yes, but the pull apart basin is a complex basin. I believe it was originally part of a back-arc continental rift or extension zone graben formed by upwelled magma. The oblique nature of the subduction slab to the coast created left-lateral strike-slip movement on the north-south structures, which I believe were originally extensional structures that formed from magmas that created the core of the Andes. Pre-existing northwest-southeast crosscutting structures then were pulled apart by the strike-slip movement. It’s a complex mechanism to create open space, but that’s one of the critical things necessary for developing these ore deposits. It’s what created Fruta del Norte.
Lucero, Taricori and Cobrecon, another Dorato property, are on the same regional feature. In Fruta del Norte’s case, it happened in the Late Jurassic. However, in the case of the Dorato properties, it appears that the mineralization is of Late Cretaceous or Tertiary age, possibly some 40–65 million years old. It’s also not truly epithermal, as it is formed at deeper sub-epithermal zones with somewhat higher temperatures in the mesothermal range, more like a porphyry-type system.
It’s still unclear whether these are going to be as big as some of the porphyry gold deposits in Chile, but the Dorato properties still host sizeable deposits that will likely prove very valuable. The grades are excellent, there’s a bit more sulfides, copper and molybdenum involved than in the system in Fruta del Norte, but gold is there, as well.
TGR: What’s the next step for Dorato?
BC: The company has a lot of work ahead developing these large porphyry-style systems and precious metal-zoned deposits. Dorato has discovered three excellent centers of mineralization. There are also other geophysical anomalies that remain to be tested. The company should get some excellent hits in the lower part of the true porphyry system, which is most likely centered beneath Lucero. It has a lot of drilling left to do and a lot of groundwork, but there is a lot of encouragement.
TGR: Do you foresee Ecuador becoming more mining-friendly in the future?
BC: It can and likely will. There are political cycles. Ecuador is endowed with a lot of mineral wealth. It’s a marvelous place to explore and develop mines under the right political circumstances. Eventually, such circumstances will come about. Rafael Correa is no idiot. He allowed the government to give enough assurance to Kinross to make purchases and develop mines. He will allow certain levels of development.
However, the real development of Ecuador and the ultimate realization of its mineral wealth will only come under a different philosophy, one similar to those in Chile and Peru. Companies need encouragement because these are rugged areas—jungle that is difficult to traverse and explore, and there aren’t many roads. Companies need mining laws that will encourage them to take the difficult steps to explore the area. I think that will come, and it will probably be driven by economic necessity.
TGR: Bob, thanks for your in-depth explanations.
Robert J. Casaceli holds a master’s degree in geology from Oregon State University and a bachelor’s in geology from the University of Colorado. His mining career spans 36 years and has involved every facet of mineral exploration for precious metals, base metals and uranium. He is currently president and CEO of Creso Exploration Inc. (TSX.V:CXT; OTCQX:CRXEF). Until recently, he served as chief geologist for Franco-Nevada Corp., the world’s most-respected royalty acquisition company. He has also been president and chief executive of a TSX-listed resource company for more than 12 years and has been involved in the design, funding and implementation of numerous reconnaissance, advanced-stage exploration projects and prospect/mine evaluations in some 50 countries. He was previously president and COO of L.A. Nevada, a subsidiary of Euro-Nevada Mining Corp., for two years. His primary function was the identification and acquisition of royalty interests from mining properties located throughout Latin America and elsewhere in the world. Casaceli has published numerous technical and scientific papers. His technical skills are enhanced by his extensive experience in negotiating mining deals, structuring legal agreements and establishing companies in many countries.
By Claus Vistesen, on February 14th, 2011
One of the main investment and trading themes crystallised during Q4-10 was the move out of emerging markets and into developed markets. As all themes, it started as a contrarian misfit moving against the truck loads of capital piling into emerging markets but has now reached its mature state flapping its wings as a beautiful butterfly and the main investment theme du jour. We know this because the Economist devoted a piece to it in their latest print edition;
(quote, the Economist)
One reason to look elsewhere is that Western economies’ prospects look sunnier than they did a few months ago. American consumer confidence has rebounded more quickly than expected, for instance. Much of the money that has come out of emerging economies has gone straight into developed markets, in what Michael Hartnett at Bank of America Merrill Lynch has dubbed the “Great Rotation”. Rich-world stockmarkets may also be the big beneficiaries of reallocation by fixed-income investors who believe that the bull run in bonds is over, says Nick Smithie of UBS.
The obvious question is whether it is too late to join the party now that the story has hit the mainstream press. The trend following crowd would doubtlessly argue for you to jump the bandwagon.
In so far as goes the idea that the relationship between emerging markets and developed markets should be enjoying an equal share of the excess liquidity sloshing around, there is certainly plenty of scope for further out performance of the developed markets. This notion is supported I think by the fact that the overall emerging market index has only recently started to correct downwards (in the aggregate). This is in contrast to the canary in the coal mine in the form of India whose equity markets have been resolutely hammered so far in 2011. This is perfectly predictable since India runs a current account deficit and is largely funded by short term maturity inflows.
I would even venture as far as to call it the revenge of text book economics as the current state of affairs fits very well into the (fairy)tale taught on international finance programs of the benefits of international diversification. A fully diversified international investor would thus currently be sporting a nice gain on any stock holdings in developed markets (in the US in particular). Indeed, if the main story of the post financial crisis world has been that of impaired monetary transmission mechanisms in the US and thus how Bernanke’s free money flowed towards emerging markets, it seems as it has been temporarily restored.
Or has it?
It is precisely this meltup which has emerging market central banks scrambling to cool down their economies and which has currently set a vicious circle in motion for EM risky assets. Higher inflation in itself is detrimental to economic activity and as higher activity leads to higher interest rate/tightening expectations which again leads to lower economic activity. Within this circle the dilemma persists. How do you cool down your economy when raising interest rates runs the risk of attracting even more yield hungry capital? Turkey recently lowered interest rates and while everyone seems to be talking about the Indian central bank being behind the curve I think it is deliberately pursuing this strategy as it knows how raising interest rates may not be consistent with its objectives.
I for one was quite worried to hear Bernanke openly admit that the main criteria of success of QE2 is the fact that the stock market is going up. My view of the Fed policies is that they are trying to put weight against what they see as an inevitable and long process of deleveraging in the domestic economy and that this deleveraging is best dealt with in the face of rising risky assets (which is obviously de facto true in the US with a strong wealth effect from rising stock prices). I believe that the Fed is right to pursue extraordinary policies, but by marrying himself to the stock market Bernanke is playing a game he cannot win.
The main effect of QE2 was always to bid up commodities and risky assets across the board and together with a number of adverse supply shocks in the agricultural sector we are looking at a nasty meltup in 2011. I think that the current goldilocks recovery in the US supported by no imminent threat of interest rate hikes by the Fed (no matter the benevolence of the data!) is bullish for US stocks, but nothing goes up for ever and technically we have been on the brink of a correction for a long time.
If we manage to blow off some steam from the US stock markets, I think it will be a good idea to sling shot your way onto the developed market out performance theme, but for god’s sake do not buy US beta for the long term at these levels!
TMM remind us that even with consensus trades, there is a limit to the degree of love and trend following.
As for DM Equities, we are just soooooo wanting them to fall over, having been on the bull bandwagon for so long, it’s time to switch allegiance and play for a move down… How far? Not sure yet and we’ll play that by ear, but new highs will have us out.
Perhaps spoken of one who would be able to take profit on a long DM position, but also an astute warning to those about to jump in the pool.
In this vein allow me to offer the contrarian perspective on the current consensus trade;
Look to build emerging market exposure in your long term investment portfolios
Chris Wood who pens the indispensable Greed and Fear for CLSA puts it very well;
With so much money invested in markets like India and Indonesia last year, there is clearly the potential for more selling on a flow of funds basis whatever the fundamentals. Still GREED & fear remains of the view that one of the most interesting opportunities provided by the present inflation scare will be for investors to buy the likes of India and Indonesia at significantly lower levels.
If 2011 turns out to be marred in a nasty meltup of headline inflation, emerging markets will suffer much more. Wood notes India and Indonesia where I have my eyes firmly fixed on the former for some stock pickings. But even by buying into beta at good levels, I think you can secure some nice future returns on that pension portfolio. Actually, this is a prime lesson in the difference between trading and investing for the average retail parasite.
What happened last time we saw developed market out peformance?
Looking at the chart above the astute investor will immediately note that the last time we saw significant out performance of the developed market sector, it coincided with a sharp drop in global equity prices (you know, the crisis and all). Now things are obviously different you might plead. We are in a nascent recovery and global equity markets are powering ahead even as emerging markets struggle no doubt much to the pleasure of authors of finance text books.
However, it is quite easy to build the case for a very sinister hoax played on international investors piling into the broad based recovery story. Thus, I don’t think that the global monetary tranmission mechanism has changed. Structurally, we still have to much capital chasing to little yield and while it should favor emerging markets in the long run it adds volatility their business cycle and thus the global business cycle too. The main worry at the moment in this respect is the prospects of a hard landing in China which would have strong global effects. In this sense, if the emerging markets experience a hard landing it stands to reason that it will be a global one too, de-coupling runs two ways!
This then becomes an argument for reducing the blind exposure to the QE2 punt and the goldilocks US recovery.
Remember the Fundamentals
Despite the current surge in headline inflation the main challenge for developed markets which remains fundamentally unsolved is how to generate growth while simultaneously consolidating public finances. The Eurozone periphery is merely a taste of fundamental problems to come. The recent fiscal monitor by the IMF should put a scare into even the most ardent bull;
Despite the improving global outlook, the pace of fiscal consolidation this year is slowing in some key countries. The United States and Japan are adopting new stimulus measures and delaying consolidation relative to the pace envisaged in the November 2010 Fiscal Monitor. The underlying fiscal outlook has also weakened in some emerging markets—among them are several that need to build larger fiscal buffers, particularly in the face of surging capital inflows, overheating, and possible contagion from advanced countries. By contrast, advanced economies in Europe are projected to continue tightening policies amid heightened market scrutiny in several countries. Altogether, sovereign risks remain elevated and in some cases have increased since November, underlining the need for more robust and specific medium-term consolidation plans.
I am not sure the IMF really knows what it is they are saying here, but go to the two charts in the blog post by Carlo Cottarelli and notice that advanced economies are to consolidate less than expected in 2011. Obviously, this is unsustainble but the flip side of this argument (and something I’d wish the wise people at the IMF would push stronger) is that national governments are waking up to the cruel reality that without fiscal stimuli there will be no growth. Indeed, some politicians will have to navigate an environment where the absense of continuing support by fiscal spending (financed by the central bank or domestic savings) is the only source of growth until some form of export apparatus might be put in place if at all. Allow me to repeat myself for the umpteenth time.
What happens once it dawns on investors that the trend growth rate in many OECD economies is negative absent fiscal deficits? Indeed, what happens when everyone realises that the only way to survive is to export and build a strong net foreign asset position?
I believe that this fact as it will reveal itself moving forward will have wide implications for sovereign debt and global growth dynamics. And while the time may not be now, it also implies a wholly different approach to the recent out performance of developed markets even if this particular theme, as a trade, may still have some time to run in 2011.
By Claus Vistesen, on December 15th, 2010
I did have some plans to do a series of post to give a brief overview of my main macro and trade themes for 2011, but time has, not surprisingly, caught up with me. As such, you will have to make due with a special version of random shots.
Risky Assets to fly in 2011? – This one is a bit too general to answer in full of course, but one interesting discourse that has emerged lately is that as bond vigilantes are feasting on the Eurozone (and even going for an altogether larger prey in the US), investors are being pushed into equities.
Following a well worn cliché in the world of finance, equities is the least ugly alternative.
Now, this may only be a working explanation on the surface since the underlying move into equities is also part of a more structural consequence of QE2 since the Fed is not only trying to move investors around on the yield curve, they are also trying to move them out of the curve altogether and into more risky alternatives. In this sense, what appears to be a melt up in equities might just be a slow but steady excess liquidity driven grind. Surely, Bernanke is in no rush to raise interest rates in 2011 and if the US economy continues to slowly heal, there will be only speed bumps ahead of a general trend upwards. One interesting thing here will be how the market reacts to event the slightest hawkish tone from the Fed or perhaps even a downtoning of the dovish stance. I think; not all too well but precisely because of this assumption (which I think many share with me), the Fed will remain uber dovish as far ahead as the eye can see.
Technically, I think the melt up towards the end year is in for a rude stop in the beginning of the year and I have the SP500 declining to about 1180-1190 in January. This would then provide a potentially tasty entry point for a 2011 rally. Other than a veritable cataclysm in the Eurozone (which appears the main source of systemic risk at the moment) and China suddenly slamming on the breaks in an unduly harsh manner, I see little resistance for risky assets in 2011. This is especially the case as the BOJ and the ECB will likely add their interpretation of “QE2″ to the table to respond to the ongoing sluggishness of their respective economies.
We have already gotten a barrage of 2011 predictions and outlooks from research houses, banks and other financial sages and quite frankly it is quite difficult to get a bearing on it all. I did find the Barclay Macro survey quite interesting though as it shows that about 70% of all investors see risky assets in the form of commodities and equities to outperform in 2011 while US treasuries will underperform. The underlying rationale is again quite simple I think. Given the severity of the crisis, monetary policy will tend to apply the brakes with a considerable lag and if 2010 saw the first signs of the effect of such a lag, 2011 could give us the full force. Again, this is especially important to note as the ECB and the BOJ might just be about to join the party.
On the other hand, “underperforming treasuries” will also present Bernanke with a dilemma in the sense that the extent to which the infamous bond vigilantes fancy more than a pot shot on US bonds he may be forced to apply even more pressure to keep yields low.
Low Growth in the OECD – This one is hardly news and hardly one exclusively for 2011 either. However, I still think there is a lack of recognition of just how low growth in the OECD is likely to come in for the coming years. In this way and just as investors have their focus set on outperformance in Asia and Latin America, I think that the ultimate growth outcome in the OECD will be worse than the market currently expects.
The point I am basically getting at is that we need to think about the fact that the Eurozone periphery essentially are going to be hampered by negative trend growth rates and that the rest of the OECD will be dependent on exports to grow (think mainly Germany, Japan and now also the US). Apart from any productivity miracle or some other exogenous source of growth, the growth engines in the OECD are simply tapped out. Indeed, this is probably the most important structural macro theme for me at the moment.
Now as for 2011, a lot of this will also depend on whether economies really intend to walk the walk in terms of fiscal tightening or whether they are simply talking. Clearly, countries under the spotlight in the form of the Eurozone periphery will see their growth rates severely dented by the need to consolidate public finances. In the US on the other hand, I think the latest estimate for the 2011 budget deficit is 10% of GDP which is hardly tight.
According to the IMF’s latest forecasts “Advanced Economies” will be running a deficit on the structural balance to the tune of 5% in 2011 and the G7 as a whole one of 5.88%.
But all this only goes to accentuate the issue since if there is one thing we have learned by now it is that one cannot borrow ad infinitum and especially not as you are essentially borrowing against a depreciating asset in the form of future growth held down by population ageing. So the big (as in biig!) question is; if you substract the 5% government spending induced deficit from the equation what kind of trend growth rate is left in the OECD as a whole?
Clearly, we know that some economies are now basically saddled with negative trend growth rates, but I think that even the aggregate number in advanced economies would be scary reading. We could call this decoupling in reverse and thus how vulnerable we now are to the continuing growth spurt of Asia and other so called emerging economies. But in the end, it is a basic question of not having any more components of the national identity to lever up as it is obviously clear that governments are only going to find it increasingly difficult to borrow (even in the case of very generous central banks).
Indeed, as we move forward I see this low growth environment for the OECD (and actual negative trend growth in some economies) as one of the main components in my call that we are going to see some spectacular and costly sovereign defaults in the OECD edifice going forward. On this, I think the current mess in the Eurozone is only the beginning.
The Euro and the Eurozone - Actually, I have not followed FX a lot lately so I am a bit of out form here, but I still use my Old Maid metaphor when thinking about big global currency movements and intra G3 movements especially. Interestingly, 2010 saw the JPY as a looser and thus holder of Old Maid in the sense that it appreciated significantly against the USD and Euro. In essence, the USD was being held down by the Fed’s policies and the Euro actually acted as a nice buffer against the crisis in the Eurozone as it fell strongly throughout the spurts of Eurozone tension in turn providing a much needed boost to external competitiveness when it was needed the most.
In principal, these trends do not stop at year end and will continue to dominate at least part of the intra G3 movements in 2011. The main question is what kind of bazooka, if any, the BOJ will pull out to revive the ailing Japanese economy. If it becomes the kind of shock and awe many are expecting we could be into a nasty long squeeze in the JPY. This also goes for the Euro in the context of the ECB being forced, kicking and screaming, into supporting Eurozone bond markets. I hold this to be almost given since the current setup simply does not work.
Today, Trichet called for more bold action on the fiscal front and in terms of capitalising the stability front (didn’t he just tell them to tighten their belts?). This is no doubt part of a futile attempt to preempt any defacto query, to the ECB, by part of the EU on taking an active and open role in the bailout. Trichet and his compadres are not going to like it, but the alternative asking Italy and Greece to pay for the bailout of Spain who in turn helped finance Greece and Ireland is simply hogwash.
As I have noted on several occasions; should the issue turn out to be contained with Greece, Ireland and Portugal the fiscal solution/stability fund would suffice, but evidently we are looking at a much more structurally problematic issue and Spain is surely next in line and even yields on German and Belgium bonds have begun to break loose. As such, it is becoming increasingly clear that the ECB will have to take a more active part beyond “simply” supplying liquidity to the banking system and buying bonds on the drip (or covertly).
I tend to have little opinion on the EUR/USD in general, but I will timidly forward the idea that we can expect the ECB to surprise with some of open support to the periphery, it should provide some pressure on the single currency. Yet, it is also fair to assume that the extent to which risky assets fly in a bath of excess liquidity the USD will depreciate and the Eurozone will gain on carry flows as interest rates are still higher in the Eurozone (especially, if things get so calm that the ECB starts turning hawkish again, but this may be selfdefeating in itself of course).
Emerging Markets – Well, the EM story is important enough to merit its own section even if it is intimately tied to the risky asset story. Yet, there is no need to re-invent the wheel and in this sense I think that Morgan Stanley’s Manoj Pradhan’s recent note on the 2011 EM outlook is pretty much accurate in all the important areas.
Especially his first point is important on structural outperformance by the EM relative to the developed world whereas 2011 should see EM growth cooling and, hopefully, growth in the developed world nudging up. As such, 2011 will see relative outperformance by developed markets. This is a bold, but also astute, call. It is bold because I think the link between the EM and DM is still too strong to see DM growth decouple entirely for a relative slowdown in emerging markets. In this sense, how far and how fast monetary policy in emerging markets are tightened in response to fears of overheating will be key. It is astute because, all things point in the direction of a slowdown in the emerging world after a breakneck 2009 and 2010 and in this sense, on the margin, perhaps the developed world is the place to be in 2011 on a tactical basis.
I also like that he spends some time on the inevitable, but important, process of rebalancing away from a reliance of an overlevered Anglo-Saxon consumer in the OECD (and of course, a now cracked Eurozone periphery). Reverse decoupling and rebalancing towards the emerging markets are two of the main global discourses and real economic drivers at the moment.
Finally, I think it is also important to re-emphazise the basic problems emerging markets face as they try to cool their economies through higher interest rates only to allow more hot money flowing in. The policy mixture is obviously being developed as we move along with some form of capital controls being implemented across the board. In a world of structural excess liquidity this policy dilemma becomes an additional issue on top of the more traditionally discussed trilemma.
As such, I am large cautious on the emerging markets going into 2011 as I think they are overloved, but the long term bull call stands uncontested. In addition, there appears to be general acceptance and expectation that key emerging economies (China most notably) will react strongly to any lingering signs of overheating and just as Bernanke might not care that his low interest rates will fuel asset bubbles far from the shores of the US, so may Chinese policy makers care very little if they have to slam on the brakes to the detriment of global growth and OECD’s recovery.
By Claus Vistesen, on November 23rd, 2010
I don’t suspect anyone remember part 1 of this series so if you want to refresh your memory, you can have a look here. In that note, I treated some of the more theoretical issues in the form of how demographics might affect long run growth as well as open economy dynamics. In particular, I discussed the broad tenets of the life cycle framework and how it relates to savings and investment behavior as a function of ageing. In particular, I discussed where I think there was room for improvement and further study.
So, in this one I would that I would look at an all together more practical topic in the form of asset demand and prices as a function of demographics. Again, this is a substantial area in the finance and macroeconomic literature and I will not give a detailed literary review here. Besides, if you want to move straight to investment and portfolio implications this piece by Alicia Damley and this piece by Ed Dolan are really spot on in terms of what you need to think about. Basically, you want to buy the young guns and sell the old farts and the key to obtaining this insight is to remove the focus from population size to population structure (age structure). I have been harping about this since this blog’s inception 5 years ago, I am doing a PhD about it, so it is with pleasure that I see the discourse hitting the tapes of Seeking Alpha which indicates that it is grabbing hold of other people than those stuck in the university ivory tower.
In this sense, this is hardly a new story . Emerging markets represent the main investment story in a post Lehman context. Everyone wants to buy India, China (although she is quite different), and Brazil and as a result of a myriad of ETFs and other types of market trackers, you don’t need to know your way around the streets of Bangalore to gain exposure to the Indian growth story.
This is a turkey shoot then. And I largely agree with the main thrust of the argument.
The real maturing of the emerging world which began some 10-12 years ago and which will continue for the next decades is undeniably a force of good for savers and investors and the real question is whether it is too good, and thus whether there will end up being too much capital chasing too little yield. In order to understand this link, you would need the second part of the equation (see part 1) and understand how demographics affect capital flows and the transfer of savings between economies as a function of demographics.
In this note I will talk about the idea of a life course but in the way that it is traditionally narrated. As such, the life course is a sociological theory which describes phases of life and in this sense it is more topical than the idea of a life cycle which only describes the flow of investment and savings. Indeed, in finance and economics you only hear about the life cycle even if scholars who investigate for example the dynamics of house prices as a function of demographics essentially are deploying a life course framework.
What is the Life Course then?
Well, Wikipedia does a good job of explaining it for the layman and this small snippet also captures the essence quite well especially
In particular, it [Life Course Theory] directs attention to the powerful connection between individual lives and the historical and socioeconomic context in which these lives unfold. As a concept, a life course is defined as “a sequence of socially defined events and roles that the individual enacts over time” (Giele and Elder 1998, p. 22). These events and roles do not necessarily proceed in a given sequence, but rather constitute the sum total of the person’s actual experience. Thus the concept of life course implies age-differentiated social phenomena distinct from uniform life-cycle stages and the life span.
The only mental leap you need to perform here is to replace socially defined events with economically defined events and you have yourself a working model. Now, if the finance geeks out there think that I am turning soft and if the sociologists believe that I am reducing their complicated theory of human lives into numbers and equations, both groups have my symaphaties.
Yet, this is a part of my master plan to elevate ageing and the change in age structure to the ultimate unit of analysis on a macroeconomic level. And in order to do this, we need more than merely the life cycle or the life course. We need them both. In fact, only by fusing the two will be able to develop a framework which is rich enough to deal with the complexities of ageing and macroeconomics. Indeed, I am betting a good deal of my academic oevure on this.
Consequently, if a socially defined event of interest to a sociologist or demographer might be the age of marriage, age of first child birth, age of first encounter with alcohol, age of sexual debut etc, then an economically defined event be something along the lines of age of maxmimum borrowing relative to asset value, age of purchase of first home, purchase of durables as a function of age as well as of course, the main topic in the financial literature as it currently stands; portfolio choice as a function of age (stocks and bonds basically, but you can vary the portfolio here as much as you like, at least in principle).
So, this inclusion of life course into the general thinking of macroeconomics is crucial and even though economists always talk about the life cycle, they are often implicitly assuming a life course perspective.
In the end, I will keep it short here.
There is a myriad of sources on aging and asset prices and demand in general. The main man in the world of economics and finance is James Poterba from MIT (just check list of papers) and I would emphasize in particular the strand of literature that deals with housing and demographics (I have a paper coming here).
By Claus Vistesen, on October 8th, 2010
I have just been listening to Ben Davies’ podcast (see also FT Alphaville here) from Hinde Capital about the funding issues of the Japanese government and the points he makes are important. I have used the metaphor of Japan as a bumblebee before and while I believe that the story on Japanese savings may just be a little more complicated than many believe I think Ben points his finger at two very important points. One is how Japan has difficulty with both deflation and potential inflation (higher yields) at the same time which not only puts the economy in a very tight spot, but also locks in Japan towards a balance between veering to far in either direction, a balance which can be difficult to strike. The second is that while Ben believes that Japan will ultimately pop, the central bank (and indeed Japan itself) will try to do everything it can before that happens. Especially the last point is very important. Coupled with the need for Japan to attempt to maintain a structural external surplus it brings me back to a point I have made before (and which I will continue to make again and again).
Ageing societies are not, in the main, characterised by aggregate dissaving but rather by the fight against it.
So, Japan will fight and the central bank will do the government’s dirty work and the most intriguing question here is how long it will take of unsterilised hyper-QE before an economy such as Japan stuck in both a fertility and liquidity trap [1] implodes in hyperinflation; will it happen at all(?) and what can the country do to balance the trade-off between deflation and inflation.
Finally, on Ben, he is bullish on gold but then again, he would be wouldn’t he as runs a gold fund. But there is a subtler point underneath the reaffirmation of the bull market in gold since Hinde is also, following Ben’s comments, long volatility, a bet which has not, yet, paid off (and one would assume the “position” has some carrying/opportunity costs even if volatility is flat). Or put differently, gold (precious metals) have performed strongly alongside risky assets as liquidity has been plenty but what has not happened yet is the ultimate shakeout in which volatility spikes and investors buy gold and not the dollar. I think that you need to fit two stories in your head. One is why gold might move alongside risky assets as fiat currencies are slowly debased as well as how gold should do also do well in a situation where volatility suddenly increases quickly and abruptly although I suspect this last situation is the ultimate endgame with the interim mainly being one of dollar strength in times of sudden reversals in market fortune.
But even gold can’t be a free lunch, right? Perhaps, this is one way to rationalize that fact that investor performance currently seem to be demarcated by those who climbed on the gold train a year ago (or 2-3 years ago if you will) and those who didn’t. When times are tough and volatility spikes, the USD rallies but as such events almost inevitably carries an immediate response of more liquidity so will gold (and other non-printable assets) do well. But then as liquidity manages to smooth over markets and as the SP500 starts to tick back up this should again be constructive for gold since after all; the whole precondition for low volatility at the moment is the promise of more QE from the Fed (well not quite, but still very close I think). This is then good for a long gold position but not a long volatility position although I am intrigued by the ultimate punt on the final coup de grace in which gold and volatility becomes the only place to be. Still you got to have that acking feeling on gold, I mean; either it trades as a risky asset or becomes the safe haven of choice in times of volatility. So, which is it? I don’t know, but perhaps we are going to find out very soon.
The Punchbowl
Indeed, I suspect that many readers would have counted on me pointing to gold as the ultimate punchbowl and while I can certainly envision a situation is which gold takes a 10-15% correction (or even more) the point is that this would not counter the trend (not even close). This brings me to the real punchbowl at the moment; equities, emerging markets and high beta EM currencies (Asia and Latam). I am largely indifferent to the first in the long run, long term bullish on the second, and by consequence pretty constructive on the latter as well in the long run [2].
However, in the short run I think that while the punchbowl never left the table, talks about a new round of QE and how Japan’s intervention might actually be a leading indicator of more to come from OECD central banks all at the same time as the SP500 breaks 1160 is extraordinary.
(quote Bloomberg)
The Bank of Japan may have acted first in a new round of central bank action to prop up the global economy as recoveries in industrial nations falter.
The unexpected decision by the Japanese central bank yesterday to drop its interest rate to “virtually zero” and expand its balance sheet follows the U.S. Federal Reserve’s move toward more unconventional easing. Bank of England officials will consider further stimulus tomorrow, while the central banks of Australia, Canada and New Zealand are among those now holding fire on further interest-rate increases.
It reminds me of a point made recently [3] that the marginal returns of additional QE measures (Q1, Q2, Q3 … QN) are declining rapidly. I mean, how much QE do we need before the SP500 hits 1200 or 1250 perhaps? Certainly, I think this is a worthwhile consideration when talking about the effects of QE even if the ultimate policy rationale for additional measures has intensified with the macro environment definitely turning darker in the OECD.
Actually, if you will allow me a mathematical description of this.
The first derivative of QE with respect to the macroeconomy and risky assets are positive but the second derivative appears to be negative for the macroeconomy. More and more is needed to have a smaller and smaller effect. But it is more complicated than that and some asset classes clearly have a very positive second derivative (gold for instance) and look at those poor emerging markets as well. More and more liquidity chasing relatively few assets and high yield opportunities are relatively scarce. This is then a positive second derivative and a clear risk of a bubble.
Quote Bloomberg
Emerging-market borrowers are on course to sell more bonds than ever this year after yields hit record lows and developing economies rebounded faster from the credit crisis than advanced nations. Governments and companies in developing countries including Vale SA, the world’s biggest iron-ore exporter, and Korea Electric Power Corp., South Korea’s largest electricity producer, borrowed $196 billion from July to September, the most for any quarter, according to data compiled by Bloomberg. Bond sales surged from $157 billion in the second quarter of 2010 as yields in developing countries slid to an all-time low of 5.4 percent on Aug. 23 from as high as 6.8 percent in February, JPMorgan Chase & Co.’s EMBI+ index shows.
(…)
Brazil doubled the tax yesterday on foreign investment to 4 percent on fixed-income securities to stem the currency’s two- year rally and help shore up exports. The move coincided with the Bank of Japan’s reduction of the overnight call rate target to a range of zero to 0.1 percent, the lowest since 2006, and said it would set up a fund to buy bonds. Brazil’s benchmark interest rate, at 10.75 percent, is the second-highest among the Group of 20 nations after Argentina’s and is luring demand for local-currency debt. “The IOF tax isn’t enough to contain the flows coming from the liquidity injection by the Japanese central bank and global dollar weakening,” said Luis Otavio Souza Leal, chief economist with Banco ABC Brasil SA in Sao Paulo.
(…)
Governments from South Korea to Brazil are stepping up attempts to control their currencies as investors pour a record amount of money into emerging markets.
Regulators in Seoul will start an audit of lenders handling foreign-currency derivatives on Oct. 19 to curb volatility caused by capital flows, the finance ministry said today. Brazil doubled a tax it charges foreigners on investments in fixed- income securities to 4 percent yesterday. The yen fell the most in three weeks after the Bank of Japan cut benchmark interest rates and pledged 5 trillion yen ($60 billion) to buy bonds and other assets, having sold $25 billion worth of its own currency last month in the first intervention since 2004.
This is just a small smørrebrødsbord then of the effects this is having in emerging markets where more and more creative policy measures are being tried to keep the money out. This is then a strongly positive second derivative effect and one which is a key mechanism to be aware of in the global economy.
The point here is of course that there is a lack of stability. It is fairly well established from Japan’s experience that once caught in a liquidity trap and with a rapidly ageing society the extra effect of more liquidity is almost 0 with respect to the macroeconomy (until of course the balance tilts, but sufficient unto that day and all). Yet, there is always a bubble waiting to inflate elsewhere as such the Japans of the world create a huge externality in the global economic system by filling the proverbial punchbowl for risky assets.
Yet for now and as markets seem to be wanting more and more QE to push forward it appears that investors should be careful diving too deep into the punchbowl even if it currently might appear as a golden opportunity.
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[1] – For more on the fertility trap, look no further.
[2] – Although an AUD/USD at 0.97 is unbelievable to me. I think this is one of the brightest stars high their looking for a strong correction.
[3] – I can’t for the life of me remember who it was.
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By Claus Vistesen, on February 10th, 2010
The good folks at Icfai University Press and specifically the editor of the magazine The Analyst have queried me to answer some question on the Asian economies and their ascend to the top position (or not) of the global economy and what this means. They have shipped me some questions, given me a deadline and below I provide some answers in Q&A format. Enjoy!
Question: History reveals that every international crisis leaves a lasting mark on the world, once the crisis is over and the difficulties it brought have been encountered, things tend to change. Similarly, do you think that the current global economic crisis must lead to a fundamental reassessment of how power and influence is expressed through the world?
I belive that the current financial crisis have accentuated what we already knew and what has been present in the data and the discourse for some time. Specifically I am talking about the idea that big emerging markets such as India, Brazil, China, Indonesia, Chile, Turkey etc have slowly but steadily taken over as the global powerhouses in terms of economic growth and thus it is also natural that they are gunning for more political and institutional power. When it comes to financial crises in particular the latest batch of proposals from the Obama administration to regulate the financial industry is another and more micro oriented theme which is a recurring event in the context of economic crises. Crises are often, in this way, catalysts for abrupt discrete changes in the economic and political environment.
Ultimately then I think that this fundamental reassessment of power and influence in the world (both politically and economically) have not been initiated by this crisis but it may be reinforced.
Question: As the Great Depression paved the way to World War II and to a new world order, how far the present crisis produce grave repercussions on the global economic order?
This intimately depends on how you define world order naturally. If I have to point towards the most enduring change which appears to have come on the back on this crisis it is the attitude to debt and long term sustainability of public finances. Those of us who have been interested in demographics and its effect on macroeconomic processes have long been waiting for (and predicting) the inflection point where the mismatch between expensive welfare systems and the increasingly broken demographic structure as as result of persistently below replacement fertility. In this way, the ability to take on debt today as a liability for the future and despite the theatricals on sovereign spreads and CDS on Greek and Spanish government debt, are in fact fundamentally driven by long term liability problems. For an excellent excursion into this topic in the context of Australia/New Zealand and beyond I warmly recommend this one by John Hempton.
Extrapolating to the idea of a new economic order this brings us into a fundamental dilemma. With every part of the national identity overlevered [1] and in need to rebuild their balance sheet most economies are looking to the last part of the identity to make up for the shortfall of savings; the external balance. The problem is that not everyone can export excess savings (i.e. run a current account surplus) at the same time. In my opinion this is where the big new emerging economies come in and despite by personal skepticism towards China pulling the world anywhere it remains obvious that those who can reasonably be expected to run sustainable net external borrowing positions (i.e. current account deficits) are exactly those economies mentioned above who are about to ascend as the new drivers of economic growth. If they don’t, it is not easy to see where the growth is going to come from.
Question: The world financial crisis has been a defining moment in the ascension of emerging economies onto the international economic stage. Please comment.
Not really. In my opinion this goes back to the idea of decoupling from the US economy and how, before the crisis, many observers had their hopes pinned on the Eurozone (and the Euro) as well as Japan (and the JPY) to take over the baton from the US economy in steering forward global demand. In the context of Bretton Woods II this seemed a turkey shoot of an argument. Just de-peg from the US dollar and re-peg to the Euro and it is all engines go. Obviously, this was always going to be a mirage and essentially a smoke screen puffed up by those who have a fundamental desire to see the US economy fail and cave in on itself. So, why this detour in answering the question above?
Well, quite simply, the world “decoupled” for the US and indeed the advanced (G7) economies a long time ago.
From 1980 to 2008 the share of total world GDP made up by G7 economies declined from 51.33% to 42% and the corresponding figure for newly industrialised Asian economies rose from 7.17% to 21% and according to IMF this trend is set to continue. This is the real decoupling and it represents a major structural change in the global economy which goes far beyond the current financial and economic turmoil. Whether there will be anything particularly defining about the role of emerging economies as a result of the financial crisis is too early to say. A sovereing default in Greece or elsewhere in the Eurozone should increasingly make investors aware that global risk is not primarily present in emerging markets but actually right at the heart of the G7 and OECD edifice. Perhaps this will be a definining moment, but the general ascend of big emerging economies to the center of the world stage is not a product of the current turmoil.
Question: To what extent will emerging economies remain the drivers of global economic growth in 2010?
To a very large extent I would argue. In 2010 the IMF estimates (in their October 2009 Outlook) that the world economy will resume growing at an annual rate of 3.1% after having contracted by -1.06% in 2009. Breaking this up on the major advanced economies (G7) and developing and emerging economies the IMF estimates that the former will grow by 1.7% and the latter by 5.1% in 2010. Yet this difference does not tell the whole story. Consider then the fact that measured in US dollars (current prices) the share of world GDP made up by the G7 as well as the emerging and developing economies was 53.8% and 30.7% respectively. Yet still, and out of a total estimated value of 2010 world GDP growth at trn 3.267 USD the G7 is expected to contribute to this with only trn 1135 USD while emerging and developing economies are expected to contribute with trn 1674 USD.
More generally, this is a tendency we should expect to continue. Consequently and while global GDP forecasts into 2014 are quite fickle, forecasts by the IMF has the current price value of total world output (in USD) rising from trn 60.429 USD in 2010 to trn 74.660 USD in 2014. Out of these trn 14.165 USD, the G7 and the emerging and developed world are expected to contribute with trn 4886 USD and trn 7871 USD respectively.
In this way and I hope that my readers will forgive me the excessive arithemetic; if we take the IMF’s forecast to heart, emerging markets are definitely going to be the main drivers of global headline GDP growth in 2010 and beyond.
Question: As the evolving international order is going to be Asia centered and polycentric for a variety of reasons. Do you think that India is ready to play a larger role to ensure stability, security and peace in the world?
I sure hope so. A lot of the future stake of the global economy is pinned on India, China, Brazil, etc to develop and evolve both politically and economically. India already plays a very big role in the global economy, but is somewhat dwarfed (in terms of attention at least) by China. However, I believe this will change. Despite some well described and severe issues with a growing gender gap (which is also an issue in China) India is set to enjoy a much more stable and slow demographic transition into old age than China who will age very quickly due to its one child policy.
In this sense I forsee that India will slowly but surely take over from China as the big global emerging economy powerhouse. However, and beyond the obvious political responsibility this entails it also comes with an economic ditto. Thus, one of the biggest problems with China is that she will never be able to run a respectable external deficit that would resolve and alleviate global macroeconomic imbalances. A deliberate mercantilist policy and the effects of the one child policy which strips the economy of the capacity to suck up its own (let alone foreign) savings are two crucial factors here. In my opinion we have one shot to correct these global imbalance and much will hinge upon India (and the rest of the emerging pack) here. Specifically, India must ensure that the demographic transition is kept in check from below as well as, currently, from above. By this I mean that Indian must ensure that it does not fall into a fertility trap with total fertility rates lingering below 1.5 children per woman. Secondly, India should shy away from mercantilist policy. Standard economic theory tells us that external borrowing is not an ill if matched by a sound and long term oriented investment policy as well as capacity in the economy proxied by a large share of young to mature workers out of the total population.
Especially the argument on preventing fertility to fall too far and too rapidly is quite politically incorret at the current juncture with climate and overpopulation (still) dominating the discourse. However, it is crucial in my opinion that we are able to differentiate the debate to look at both sides of this coin. Otherwise, India and the rest of us will regre it.
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[1] – (investments, consumption and the government)
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