Expect commodity volatility as East-West tug o' war heats up - Power

Investec Asset Management, investment strategist, Michael Power believes that the balance of economic power is shifting from the west to the rest and taking commodities with it.

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GEOFF CANDY: It is a little late but here it is nonetheless, welcome to this week's edition of Mineweb.com's Metals Weekly podcast. Joining me on the line from Cape Town is Michael Power - he's an investment strategist at Investec. Michael there is lots happening at the moment. We saw the Chinese cutting interest rates for the first time since 2009, very little being said by Ben Bernanke and a lot of concern still in Europe. It feels like we are back on a knife edge, although some would argue we never really left it. Where do you see things placed at the moment?

MICHAEL POWER: I would agree we probably never really left it. We just had a little bit of the sugar high that comes with all these various rounds of quantitative easing but the reality is that they've never truly addressed the underlying problem and it's not a liquidity problem it's a solvency problem and essentially there's an enormous amount of accumulated debt in the west that has been shifted from private balance sheets to public balance sheets and now the public balance sheets are having difficulty financing it. And, slowly but surely, the bond markets are picking and choosing between the weak and the strong and the strong. In the strong countries, markets are in a sense over-rewarding, which is why yields in the United States and the UK and Germany have been contracting, whereas in the weak places yields have been widening and obviously that points the finger particularly at the moment at countries like Spain.

GEOFF CANDY: I know conversations that we've had with you over the years - you talk very much about the movement between the west and the east and I think that is carrying on. But if we look at what's happened in China, what should we be reading into the fact that they're cutting interest rates?

MICHAEL POWER: Well look I think that nobody in this global world of ours is going to escape the fallout from such an extraordinary implosion as we're now witnessing in Europe especially, although let's be under no illusion that the United States has very serious problems at the moment is just papering them over, and never was the phrase more appropriate, with the printing of money. So I think as it were, there is a global bow wave that is affecting everybody and yes, you have seen external demand for Chinese products slow down and that has a knock-on effect on the economy, which is why if necessary first to cover reserve ratios and now, at long last, they're starting to cut interest rates. But at least they've got both reserve ratios and interest rates to cut. The west is pretty much out of road when it comes to that.

GEOFF CANDY: What does that mean for the west going forward? What scenarios do you see playing out there, particularly maybe if we start with Europe?

MICHAEL POWER: With Europe I think that essentially it's going to be, the nicest thing one can say is, becalmed for quite a long period of time. Ultimately I think demographics are catching up with Europe - demographics that is meeting with democracy that has actually part of the problem today and these are not easily solvable problems. So I think that Europe will be becalmed. Parts of Europe, especially northern Europe which has relied on Vorsprung Durch Technik (progress through technology) advancement through technology and to some extent, design will be somewhat immune from the fallout and I make that qualification somewhat. Even in Germany things are slowing down at the moment, but I think southern Europe in particular is going to have to re-invent itself and I can't see it doing so within the eurozone simply because it is no longer competitive for that which it sells, which is essentially sunshine.

GEOFF CANDY: And I suppose as well we get the sense that there's going to have to be a lot of fast talking to convince people that have been promised these kinds of lifestyles for so long that they're actually perhaps going to have to take a haircut.

MICHAEL POWER: Yes and its very interesting to see in the United States that in the recall election that took place in Wisconsin, the side that was essentially arguing for the reining in of spending actually won, notwithstanding an enormous amount of union expenditure and support for the guy that was opposing him. So maybe there is some hope in that one example. But I'm not confident to be perfectly honest. Weaning over-generous democracies off their over generous subsidies and payments that they're making to the people at large is not going to be an easy process.

GEOFF CANDY: Moving to the US quickly, clearly we're waiting to hear what happens in the Senate today [Thursday] when Ben Bernanke speaks, but what is your view...

MICHAEL POWER: Well I'm not holding my breath either for Ben Bernanke or especially for the US Congress which is really a truly appalling example of what a legislative group can become. They haven't passed a budget in three years and as recently even the Speaker called them a bit like trying to keep 51 frogs in a barrel. It's just not happening and I'm not impressed and I'm not hopeful and I think that the United States is largely in denial of the serious problems that it faces. It will run, of all the eastern countries and indeed including Japan, by far the largest budget deficit this year. They're just papering over the cracks. When this fiscal cliff which they've got to face at the end of this year hits them, I think things are going to get a lot tougher, very, very quickly.

GEOFF CANDY: What does this all mean for commodities?

MICHAEL POWER: I think there's a bizarre thing - tug of war that's going on at the moment between the west and the rest. The rest, especially in the sense that consumers like China and they're pulling but slowly but surely the west is falling over - and you have that image of people falling over in a tug of war. I think each time they fall over and the prices go down, that refreshes the cost advantage that China is now having to face, and gives them even more energy for when they pull next time because they're pulling from a lower cost base. So actually I think perversely this is part of a process of shifting the balance of economic power from the west to the rest and is a necessary ingredient in the process. It means that commodities will periodically suffer these down drafts as another part of the west falls over simply can't stand the heat. So do expect volatility. But I do think that this is essentially a secular shift in consumption patterns. I don't see the supply side necessarily over the medium term keeping up with the demand side and I do think that the upward direction of commodities is broadly intact. But as there was in 2008 - 2009 there will be occasional pullbacks in that process, and we're experiencing one at the moment.

GEOFF CANDY: With respect to gold, particularly there's been a lot of talk relatively recently about whether or not it is a safe haven asset if one can call it ,as volatile as it has been, a safe haven asset and particularly its role within the monetary system. There's been talk about it perhaps becoming a tier one capital ratio asset and those kinds of things. Clearly there's a lot going on in the gold market, but how much of it is likely to go forward?

MICHAEL POWER: I think first of all I'm not sure that gold has been that volatile especially when you compare it to other asset classes and yes, it has its periods of up and down, but they're relatively speaking quite tight and if you look at the long-term map, its actually quite an impressive rise that you see in gold over that period and I think that's going to continue. I think that the idea that it could actually formally become reintroduced in some way to the global monetary system is not likely, not possible. I just think when genie is out of the bottle and can't be put back in it I don't see any form of even quasi gold standard returning, but that is not going to stop the central banks of the rest quietly picking up gold when they can in the next six, nine, 12 months and the Chinese as you pretty much know are as well as being the world's largest producers of gold now, the world's largest buyers of gold and all that is produced within China pretty much ends up in the central bank and they still import more from offshore. In fact they're currently running at about 26% of run of mine production being consumed in China, and only 25% I say only 25% in India, but between the two of them they're now 51% of global consumption.

GEOFF CANDY: Then just to close off with, from a strategy point of view then, where should one look at placing one's assets?

MICHAEL POWER: Well I think at the moment one shouldn't be looking at placing your assets anywhere other than in ultra-safe, relatively liquid short-term deposits and other instruments. But at the same time I think you should be doing some really deep research as to where you want to be in the medium term because as and when one engages this market and I don't think one will be doing it particularly actively over the next two quarters, but as and when one does, there will be value everywhere. So you can actually afford to pick your asset class according to where you truly want to be over the long term and I think this is a unique position which we probably haven't been in for a very long time.