China Shows the World How to Stimulate
Australia bails out economy - Bad.

US bails out economy - Bad.

Europe bails out economy - Bad.

China bails out economy - Good.

Well, not quite. For a start, the AU$849 billion ’stimulus package’ proposed by the Chinese sounds like a lot of money. And it is. It is more than the US government is spending on its TARP initiative to bail out the credit market.

But at least the Chinese money might be spent on something useful. The US government is spending nearly the same amount just to buy dodgy debt.

The one thing we don’t know about this package is how much of the USD$586 billion is additional money to what had already been promised.

For instance, back in July US investment firm Merrill Lynch estimated Chinese infrastructure spending to be USD725 billion per year over the next three years. Sure, things have changed a bit since July, but there is no evidence yet that this is entirely new money.

Even so, it is still significant. So if we suppose the USD586 billion is added funds then it will likely take Chinese infrastructure spending to north of USD$1 trillion per year.

The upside is twofold. First it is being spent on things that country needs. Second, if it wants to, China can pay for it in cash, unlike in the US, Europe and now Australia where ’stimulus’ packages will have to come from debt.

And then we have the Australian government version of a stimulus. Give the money to a basket case industry and hope for the best.

The one positive about the hand-out to the three Australian based car manufacturers is that it involves them spending $3 to get $1 of government funding. To be honest, we’re not sure that is likely so the taxpayer’s $6 billion should be safe.

The automotive industry in Australia employs about 60,000 people directly and up to another 200,000 in related industries. It is a big employer. But does it warrant special treatment by the government on this basis alone? We don’t think so.

Our guess is that government’s view vehicle manufacturing the same way as they view national airlines: a ‘badge of honour.’

Since July, commodity bulls have been trampled during the worst credit crisis in history. The entire complex has gone from being extremely overbought in June to heavily oversold in late September.

In just 30 days, the markets have violently transitioned from concerns about inflation to a sudden panic over deflation. The credit crunch has stopped inter-bank lending and corporate borrowing, leading us to the worst panic in American capitalism since the 1930s.

It’s also resulted in the most indiscriminate commodity sell-off since the bull market began in late 2001. And 2008 might be the first year since 2001 that commodity benchmarks finish in negative territory.

And until the deflation (i.e. the environment of rapidly declining prices) ceases, commodities will remain vulnerable. Never in the history of capitalism have commodity prices rallied during a severe contraction in bank credit.

No doubt you’ve already read numerous financial articles that all began with…”In these difficult times.” These days everyone seems to have a different opinion of why the markets are down (including yours truly).

But the fact is this isn’t the first time we’ve experienced severe turmoil in the financial markets, and it won’t be last. But it seems the big industry players in the market never learn from their mistakes. Indeed, time and time again, sooner or later, the pain withers, and the greed factor comes back.

We have lived through investment bubbles and calamities for centuries. In the 1800s, it’s said that even the British royal family got swept into the investment fad at the time. If you want to go back even further, the Dutch traders had their own famous bubble in 1636 when speculators inflated the price of tulip bulbs.

Yes, the speculative bubbles and crashes may differ over time but one thing remains the same: When all is said and done, everyone wishes they had cashed out just before the bubble began in the first place. But as we all know, only a few fortunate investors manage to get out in time.

But imagine how wonderful it would be to not have a care in the world when the market falls another 300 points. Imagine not even bothering to check your account statement because you already know what it will say no matter what. Wouldn’t it be fun to watch CNBC and laugh out loud when you hear the markets just plummeted again? Saying: “Haha - not me! You can’t touch me!”

It’s all possible…with “capital guaranteed investments.”

The Ammunition You Need to Laugh at the Markets

I call them “capital guaranteed investments.” But they’re also known as principal protected notes, or structured bonds.

These investment products allow you to gain all the advantages of investing in the markets, but your investment capital is fully protected in case the market drops. In other words, you guaranteed to get back your original investment - no matter what.

You may be asking: How does that work?

The concept is actually quite simple. As you know, you usually buy a bond at par i.e. US$1000 per bond. However, you can also buy a bond at a discount, say US$950 and then it matures at US$1000. So what happens to that extra US$50? Your broker could use the extra US$50 to buy you options on a particular index, like the S&P 500. That gives you the participation in the stock market.

Most guaranteed capital investments work that way. These investments are structured so you have exactly the same rewards based on any upside movement. So if the S&P or Dow moves up 30% over two years, then you receive 30%. And if the market crashes or goes nowhere, then you still bought your bond at US$950, so it will mature at full face amount and you walk away with your original principal intact.

The only caveat is you don’t make any interest on the bond, because you essentially used your money to buy the stock index.

Super Bonds = Guaranteed Capital + Triple-Digit Gains

Here’s the norm: If your stock or retirement portfolio is up 15%, then it can only take a single stock sell-off to make that 15% disappear. Plus, your actual principal vanishes as well. But a simple structured bond can save you from that calamity.

Most investors think of bonds as long-term investments that have to be locked in. But that’s not true at all. Let me explain.

Let’s say you’re in a 3-year bond linked to the Dow. Eight months have gone by and you’re now up 12%. With a structured bond, you can promptly sell that 3-year bond and roll the 112% (your initial 100% capital plus 12% return) into another structured bond with a full capital guarantee. This way you lock in your 112% gain no matter if the market goes up, down or sideways.

In fact, you can just sit back laugh because you are now buffered and protected with your 112% gain. Then let’s say another six months go by and you’re up another 6%, you can roll that again and now you sitting on a protected 118%! Isn’t this amazing?

Better yet, you can invest in such structured bonds linked to a whole variety of markets, like commodities, or international stocks. Investing in oil, cattle, copper, sugar or Brazilian equities can be arduous and complex enough…but you can do it all with structured bonds.

Question: Which market will outperform all others in the next few years? Will it be the stock market, Commodities, foreign currencies, or bonds?

Answer: “Who cares?”

With a capital guaranteed investment, you can get the upside of whichever market performs the best and deliver you those gains plus your initial capital.

Aug. 1 (Bloomberg) — China is restricting approvals for share sales to keep new supply of equities from putting additional pressure on the world’s worst-performing major stock market, two people familiar with the matter said.

The China Securities Regulatory Commission is delaying the issuance of written approval documents, the final regulatory stage, to companies preparing initial public offerings, said the people. They declined to be identified because they aren’t authorized to speak publicly on the matter.

Shang Fulin, chairman of the securities watchdog, is trying to cushion a market that plunged 47 percent this year, making the CSI 300 Index the worst performer among the 20 biggest benchmarks. About a third of IPO applications were rejected last month, compared with 8.3 percent when stocks peaked in October, based on data from the regulator’s Web site.

“Controlling share sales is an important tool for CSRC, and it’s effective in the short term,” said Leo Gao, who helps manage the equivalent of $2.3 billion at APS Asset Management Ltd. in Shanghai. “More stock sales in a bear market is bad news” for investors.

There were 91 billion yuan ($13.3 billion) of IPOs in China in the first half, a 26 percent drop from the same period a year earlier, according to data compiled by Bloomberg. The CSI 300 fell 0.9 percent at 9:35 a.m. local time today.

Great Wall Motor Co., China’s largest maker of sport- utility vehicles, had its application for a secondary sale in Shanghai rejected by regulators on July 14.

Olympic Jitters

Olympic jitters may have added to the urgency of supporting the stock market, said Leslie Phang, Singapore-based head of investment at the private-client unit of Schroders Plc, which oversees about $260 billion globally.

“The CSRC is trying to stabilize the market ahead of its hosting of the Olympics this summer for reasons of face,” Phang said. “But these measures can only provide a short-term boost and it’s fundamentals, such as higher oil prices and production costs, that will affect China’s stock market.”

The Olympics, China’s $70 billion coming-out party, kick off on Aug. 8 with the opening ceremony. The run-up to the games has been marked by complaints about air pollution and restrictions on press freedom.

Shang vowed July 30, during the regulator’s semiannual supervision working meeting, to make the market more stable. He said in June that he will “rationally balance supply and demand in the capital market and adjust the pace of financing in an orderly way,” without elaborating.

A CSRC spokesman, who declined to be identified, said he had no comment.

Share Sale Queue

Stock markets around the world have been falling as global growth faltered, a 60 percent gain in the price of crude oil in the past year fanned inflation, and the subprime crisis led to about $470 billion in losses and writedowns at financial firms.

The Chinese government has implemented measures to curb inflation and rein in liquidity. The government capped the amount banks are allowed to lend this year, and the central bank raised the proportion of deposits banks must set aside in reserve five times in 2008 to a record 17.5 percent.

There is a queue of companies waiting for written approval documents from the CSRC’s general office before they can proceed with share sales, and no timetable for giving them the go-ahead, said the people. The watchdog applies these internal controls based on its perception of market performance and the outlook.

Still, the CSRC is open to letting smaller share sales proceed, one of the people said.

Tepid Demand

On top of delays to the final approvals process, the CSRC has also stepped up scrutiny of share sale clearance given by the Public Offering Review Committee, one step before the final document that allows the sale to go ahead is issued.

CSRC’s listing panel on April 14 rejected the IPO application of Jincheng Blue Flame Coal Industry Co., according to a statement posted on the regulator’s Web site. China’s second-largest anthracite coal producer by 2006 output had planned to sell shares to help fund 9.5 billion yuan of investments.

China State Construction Engineering Corp. has yet to obtain the green light to start its Shanghai IPO after gaining the CSRC listing panel’s approval June 5.

Sales that were approved have met flagging demand. Haitong Securities Co. ended up the biggest shareholder of Shanghai Pudong Road & Bridge Construction Co. last month after failing to sell three-quarters of a stock offering it underwrote.

Citic Securities Co., China’s second-biggest brokerage by market value, had to buy 407.4 million yuan of shares in Shanxi Taigang Stainless Steel Co. this week that it couldn’t sell in an additional stock offering.

A lot happened yesterday and overnight, dear reader. It was a buffet of economic information. We’ve laid a serve of the important stuff for you below.

But the share market will probably have its blinkers on. The only thing it’ll take notice of is the Dow Jones. And the Dow Jones had another shocker. Right at the end of a good week too.

Those late-week American employment figures we mentioned earlier …well, they proved more disruptive than a dog in a bucket of cats. More Americans filed for unemployment last week than any in week since 2003.

If you work at a shopping mall in the US, we don’t envy you. Retailers in America are at the point where cost-cutting means employee-cutting. Employees aren’t part of a team anymore. They’re not a valued resource. They’re a drain on cash.

So, they find themselves trudging off the to unemployment office. With plenty of company.

GDP figures and Alan Greenspan both suggested a recession. We wouldn’t say they “predicted” it. Predicting would be calling something before it happens. There’s every chance the US is already contracting. For Wall Street, all this meant a 1.7% drop for the day.

The All Ordinaries will be working uphill till 4pm.

Retail Sales Fall Slightly

Meanwhile, retail sales came through from the ABS. An doubled-bladed axe fashioned from higher petrol prices and interest rates has been chipping away at the mighty oak of consumer confidence for about a year now. But it hasn’t fallen yet. It’s just kind of leaning awkwardly.

The numbers were down in June though. Seasonally adjusted retail sales fell by 1% from May to June. Here’s the overall picture:

In any trend, there are leaders. The two groups boldly leading the retail pack toward mediocrity are department stores and clothing retailers:

Department Store Sales

Clothing and Soft Goods Sales

They’re both trending downward.

So now pretty much every pundit is hammering on the door of the RBA, demanding a rate cut. There’s bad news for them. Glenn Stevens lines his bin with retail sales figures. The Consumer Price Index is the real scoreboard for interest rate decisions…as far as your central bank is concerned.

Interestingly, the next inflation figure may be lower. Consumers have been shopping less, for sure. You can see that above. But the big factor is the recent decline in commodities. Oil is down 16% from its year-high. Wheat is down about 35% since March. The fall in traded goods is slowly worming its way into prices as you read this.

Our stance on the topic? The RBA hasn’t got much control over the economy anymore anyway. It doesn’t really matter what it does. We’ll show you why in a minute.

Eighty Percent of Respondents are Morons

Firstly, on an ignorant note, we saw a poll in the Herald Sun here in Melbourne this week. A poll that made a swift and brutal deletion from the sum total of human intelligence.

Something like eighty per cent of respondents voted that Australian banks should be banned from raising interest rates outside the RBA’s adjustment. Splutter.

The graph below shows the market interest rate (blue), versus the RBA’s target cash rate (pink) that you hear so much about.

Banks raise funds on the open market. The open market in that graph is the blue line. Their funding costs depend more on the 90-day bill rate than the RBA’s cash rate.

So when a bank raises interest rates…it’s doing that because it’s concerned about higher market costs. Not because the RBA has raised rates. Forcing a bank to copy the RBA’s rate movement is a bit like forcing Grant Hackett to swim in the slow lane. He doesn’t belong there. And banks deserve the freedom to foul up their own business on the free market.

Something even more interesting you can take from that graph…the RBA’s interest rate movements actually follow the short-term market interest rate. At a distance too. The market rate always moves before the cash rate does.

Do we need a central bank? The one we have at the moment doesn’t do much…instead it lets commercial banks do the dirty work. Market rates go up. So do banks’ funding costs. They raise mortgage rates. The RBA plays a round of golf.

And when the RBA does raise or cut rates, its goal is to curb inflation by reducing demand. Yet the type of inflation we have now is only really linked to supply. Not enough oil. Not enough rice. Not enough aluminium.

We need a central bank like we need a fly-kick to the head.

The “Out” Economy Surges

Finally for today…it was another good month for Aussie trade. A lot of commodities have corrected. But high coal and iron prices boosted exports. Australia chalked up another trade surplus in June. We imported AU$411 million more than we exported.

It’s time to draw a contrast here. Australia has an “in” economy, and an “out” economy. The “in” economy includes people buying and selling stuff within Australia. The “out” economy includes people buying and selling stuff to and from Australia.

Until this year, both were steaming ahead. Now the Out Economy is doing all the work. Rock CDs aren’t selling. Rocks on a ship to Asia are .

On the sharemarket, the companies with a chance at benefitting from the Out Economy include agricultural, mining and energy stocks. The ones taking a fundamental beating are retailers, financials, and pretty much everyone else. We’d rather own a firm trading out of Australia than inside at the moment.

Maybe that sounds unpatriotic. But the sharemarket doesn’t usually dole out points for patriotism. And we’re only here to point out where the money’s going.

We’ve been doing a lot of that this week, during an intensive review of the Diggers and Drillers portfolio. Our mid-year review goes out to readers today. Gabriel wrote us an interesting note on nickel for the occasion…here’s a taste:

The nickel price has been declining steadily since late May 2007. Despite a consolidation phase occurred between last August and last May, the price action fell down once again soon after.

It’s now trading at around US$18,300 per tonne.

However, the current bearish trend should lose its momentum. A rebound is likely soon. Indeed, the price action has reached a new intermediary support that commodity traders will take notice of. This level, around $18,000, is the level of previous highs posted in early 2004 and in May 2005.

Previous highs often become new lows in the commodity market. Funds and traders will look at this as an opportunity to buy back nickel.

If the support turns out to be good, previous support of $25,500 will be the next target on the upside. A consolidation phase from 18,000 to 25,000 is likely.

It’s that time of year where it’s probably not a bad idea to review your portfolio. We are. The market’s down 22%. So we’re busy sorting out which D&D stocks are now just good companies at a cheaper price…and which have lost their way.

Bank earnings, as you can see, aren’t giving the market much inspiration. In fact, despite a good lead from Wall Street on Friday, they’ll probably help push the market lower.

Aside from Earnings, there are two other market-moving Es to keep track of: Energy and the Economy. There’s some great news about Energy further down…and it’s not even a fall in the oil price.

But the Aussie economy isn’t giving away any clues this week. Don’t camp out for any big announcements. Not in Australia anyway.

Over in the US though, house prices and unemployment numbers come through on Wednesday and Friday. They might be good or bad.

Actually, scratch that. They will be bad.

But the Dow Jones doesn’t care about quality…it only really gives a hoot or two if numbers surprise analysts. Be prepared for a chain reaction if that happens. A worse-than expected economy equals falling US stocks. Falling US stocks are, in the absence of anything important happening here, a bad omen for the ASX.

The All Ordinaries is sitting just above a key support line. That makes any big event more important than usual.

So we’d rather just watch the market this week. It doesn’t quite have a clear direction yet. And those US releases have the potential to louse things up again.

We did notice two key developments in the resource sector though.

US

Better than expected results from Citigroup, JP Morgan and Wells Fargo initially saw the US stockmarket off to a good start this week. The White House moved to drop its veto against the housing bill. In the case that things do get worse for Fannie and/or Freddie, the Treasury will need the power to bail them out before Congress goes to recess in September.

Existing home sales fell in June, down 16% compared to a year earlier, to its lowest point in a decade. Resales were down 2.6% and the median home price dropped by 6.1% when compared to last year. These numbers indicate that the US housing market has not yet bottomed out. As long as house prices are continuing to go down, noone can say how much the banks are going to lose and how long the downturn is going to last.

A consequence of the very high oil prices this year, is that automakers have remained under pressure. Ford announced the biggest quarterly loss ever with an $8.7 billion loss recorded for the 2nd quarter.

Asia Pacific

The Reserve Bank of New Zealand unexpectedly lowered interest rates for the first time in 5 years as growth concerns outweighed inflation concerns and signaled that more rate cuts may be on the cards. Official interest rates in New Zealand fell from 8.25% to 8%.

Inflation in Australia accelerated in the 2nd quarter by 1.5% up to 4.5%. Despite the rise in consumer inflation, the Reserve Bank has indicated that rates will likely remain on hold with a slowdown in the domestic economy expected to drive down inflation.

UK

In England, we’ve seen retail sales plunge down to multi decade lows with the sharpest drop in the numbers in 22 months. Retail sales in June were down 3.9% as fears of a recession saw consumers cut back on spending.

The hawkish stance of the European central bank was put to the test this week with very, very weak Eurozone data filtering through. German business confidence plunged below the 100 point mark as measured by the IFO index. This is the weakest reading in 3 years.

The French business confidence index saw the same type of decline. Even the Eurozone current account turned into a deficit in May.

End note

We saw another turbulent week on global markets. These big jumps up and down are typical of a bear market. Most market watchers agree that we were seeing a bear market rally which would return to the downward trend. On a positive note, we saw oil prices ease by around 15% which helped markets earlier on in the week. We have yet to see the US housing market bottom out before the end of the problems for US financials will see a turnaround.

The devil I am talking of here is oil. Oil in a relative sense is going no-where short term but has already done the damage. But the devil has also had devil helpers in the form of raw materials and labour. All of these have pushed inflation up world wide. In Zimbabwe it now takes a Billion dollar note to buy a loaf of bread - if you can find a loaf - although that country has its own set of inflation problems. But don’t laugh, in history some of today’s modern nations have had laughable inflation levels.

We knew inflation would get out of control and we smarty economists told you so a long time ago. But in fairness to you, inflation is insidious – whilst we are enjoying the party the inflation demons are at work and by the time the party is over it looks like a rampant virus and carriers out of control. Like a virus it takes a good time to get it under control.

But our boys behind the Reserve Bank Bus are experienced fighters and are doing a sterling job despite fears of political or consumer pressure. They like such buses and will do what it takes to get us there.

Most oil charts show an ABC pattern suggesting we will see some range trading. But I have found one chart – a 30 week that differs and this shows a possible scenario of maybe a little lower first and then a move up to $160.

A pullback to sub $120 a barrel may be heaven sent but in a relative sent it is very high and we still have to live in fear of such freakish levels as $160. The only saving grace is that there is some time before that will happen – 2009 – and we know anything can happen before then.

But back to oil and a chart for oil as I cant live without my charts:

China’s actual growth rate is now irrelevant: like all statistics it’s essentially a backward looking system of measuring growth in Gross Domestic Product. China’s growth remains solid, but it is slowing: the 10.1% annual rate in the June quarter was the slowest since 2005 and it had an immediate impact on global markets, pushing oil down to its lowest level in six weeks and under $US130 a barrel. The question we now have to wonder about is: is this temporary, structural, or simply the Chinese economy slowing after several years of pell-mell growth. And, remember, ’slowing’ is relative. China is not slowing like the Australian economy, nor will it end up like the Japanese, US or European economies. It could be just a normal reaction to a tightening of monetary policy by the authorities to prevent a highly inflationary bubble developing. It matters here in Australia because if it’s slowing sharply (to a level that will still be solid by any measurement), it will have a knock-on effect here on share prices, on economic growth, inflation and interest rates over the next year, at least. Figures released yesterday show that China’s GDP grew 10.1% in the second quarter from the second quarter of last year; down from 10.6% in the March quarter, and noticeably lower than the upwardly revised 11.9% average for all of 2007. And, as ‘leaked’ to Western newsagencies late last week, inflation slowed to 7.1% in June, from 7.7% in May and over 8% in earlier months.  However factory-gate inflation accelerated to 8.8% – the fastest annual rate since the mid-1990s – from 8.2% and possibly a more accurate signal on the price pressures in the Chinese economy, given the extensive price controls. The economy is clearly slowing and it raises the following questions: do the official numbers acknowledge this slowdown fully? And what does this slowdown mean for the sharp appreciation in the Chinese currency, which is up 21% since it floated three years ago; with a noticeable acceleration in the rate of increase in recent months. That appreciation has helped cut the cost of imports, enabling Chinese steel mills for instance to pay huge price rises for Australian iron ore and coal. RBA Governor, Glenn Stevens made the significant point in his speech this week in Sydney that emerging economies should be taking action to slow growth to help take the pressure off western economies and central banks. He said that emerging economies had been running loose and accommodating monetary policies, and even though growth was still strong, so was price inflation. That’s a view that was supported by the International Monetary Fund overnight which urged emerging economies to fight inflation by lifting interest rates. Central banks in Thailand, Vietnam, Indonesia, India, The Philippines and South Korea have all tightened policy in recent months as inflation has soared, driven by accelerating oil and fuel costs and a surge (now easing) in food prices. China has been trying to slow its economy through old-fashioned attempts to restrict credit growth through quantitative controls like increase the size of the reserve asset ratios banks must use to quarantine more assets from

Interest rates have not risen and still remain negative, even as inflation eases. Loan quotas are also being used, and outright bans have been reported.

Like its neighbours, China is walking a tightrope between slowing growth and surging inflation.

Price controls remain in place even though there are reports that China faces a tough summer of power shortages because of soaring coal prices and inadequate pricing has forced many small, polluting power stations to shut down. Lead, zinc and aluminium processors have cut production for the next quarter to try and help limit their demands on power supplies, but also to try and bolster sinking world prices.

Much might change later in the year, after the Beijing Games are over and foreigners have left China. Price controls might come off and then there’s the rebuilding of the earthquake hit parts of Sichuan which will boost the economy (which should in turn boost Australian resource suppliers because more steel will be needed).

The question for after the games is: will the Government allow China kick higher, having had the economy settled with some tightening, or will the slide continue (the stockmarket is depressed, compared to the seemingly endless boom of last year)?

If China rebounds towards the end of this year, where will oil copper and a host of other commodity prices end; higher?

We should not underestimate the fear the Chinese Government has of social unrest, driven by rising food costs and scattered examples of dissent (Tibet and Muslim separatists are the current groups of interest for the security authorities).

Those fears are why price controls were imposed last year, despite their distorting effect on oil prices, profits, demand and the market; its why controls were imposed on power charges, food prices and a host of other state costs.

Second quarter growth was the slowest since 2005. Exports are easing because of slowing demand in the US and to a lesser extent Europe and Asia. Imports are soaring because of the impact of the more expensive Yuan and price rises for oil, coal, iron ore, grain and oilseeds.

Second quarter GDP growth cooled for the fourth straight quarter.

China’s export growth slowed to 21.9% in the first half from 25.7% for all of 2007, as US demand weakened, and prospects for the rest of the year have deteriorated.

Price pressures have has eased from February’s 12-year high of 8.7% on smaller gains in food prices and those price controls.

Will the government relax controls straight away or phase them out? Phasing them out would allow a slower rebound in prices.

And, will the Games mean another slowdown in growth as businesses are closed for a month in and around Beijing?

Post-games, there could be a rebound in the 4th quarter simply for that reason, while inflation could rise as well.

The market is down 88. Financials down 3.3% after the biggest fall in financials in the US in eight years. Resources outperforming relatively, down 0.3%. Property down 3.4%.SFE Futures were down 37 this morning.

Dow down 85. Up 139 at best. Down 97 at worst.S&P500 nearly 22% off its October high. Paulson’s 3-point plan to bail out Fannie Mae and Freddie Macquarie initially had the market opening up 139, but when Jim Rogers got on Bloomberg and said the plan was an “unmitigated disaster” and that Goldmans were predicting more falls in the companies, the financials plummeted. Financials down 5.14% - the biggest one day fall in 8 years. 96% of financial companies on the S&P500 fell. The Fed have given Fannie and Freddie access to the discount window if need be. Fannie and Freddie initially opened up about 30% higher, but plummeted soon after on thoughts the Treasuries’ plan was aimed at depositors not shareholders – Goldmans predicted they’d fall another 35% - thrifts and mortgages down 13%. Financials also dogged by the collapse of IndyMac Bancorp which was seized by the FDIC over the weekend – it is the largest thrift to fail in US history. IndyMac had fallen 99% from its 52-week high before its final collapse and now investors are fearful of other regional banks going down – Regional banks were down 11%. WashingtonMutual fell 35% - its steepest fall ever - and National City fell 19% to a 24-year low, even as they rejected claims of financial problems amidst a run on their banks. They said they’ve seen no unusual depositor activity. Utilities were the next worst performing sector – down a relatively small 1.3%. 

Resources outperformed again - metal prices all up except for Nickel. Only 2 out of 10 sectors up – energy outperformed – up 0.8%. Fed passed new rules to crack down on certain dodgy lending practices to prevent future credit crises. Investors fled to the safety of bonds – treasuries up 26bps sending its yield down to 3.86%.

• Both BHP and RIO up in ADR form overnight, 0.48% and 0.32% respectively. BHP down 0.4% to 3974c. RIO down 0.4% to 12301c.
• Metals mostly up overnight – Aluminium up 0.37%, Zinc down 1.29% and Copper up 0.30%. Nickel was down another 4%.
• Oil price up 20c to $145.16 – above $145 for the third time this month – the price has been supported lately by President Bush’s decision to lift an executive ban on offshore oil drilling. Woodside up 2.2% to 6205c.
• Gold up $13.40 to $973.70. Newcrest up 1.7% to 3300c.
• US Bonds up with the 10 year yield down to 3.86% from 3.96%.

The Minutes of the last RBA Meeting point to rates remaining on HOLD with the comment that current interest rate settings are “exerting the appropriate degree of restraint”.

The A$ hits another high of 97.39c. We are on our way to parity. The fact that the US Government is about to quasi underwrite $5.3 trillion of residential loans through their support of Fannie Mae and Freddie Mac does nothing for the US$.

Banks smashed today – most off more than 3% following the lead from the US financial sector. Macquarie down 6%. ABN AMRO comments on the whole sector saying “given global sentiment towards financials is likely to remain negative due to the prospect of further writedowns and capital raisings, we maintain that a sustained bounce-back of Australian bank share prices is unlikely in the short-term”.

The RBA has estimated the impact of the Apache West Australia gas plant explosionon the Australian economy will take 0.25% off GDP – but gives no time frame for slowdown. WA economic output to be impacted by 3% due to the disruption.

ACCC’s July 31^st grocery price inquiry likely to have an $810m impact of lost revenues across the retail sector. Retailers down today. Woolworths loses 2.8%, Wesfarmers 3.8%, Metcash 2.3%.

• Allco Finance Group (AFG) up 20% early announcing they have reached agreement with senior banks on new financing terms which will run until September 2009 – at a margin of 3.5% if debt $600m or greater. No market cap review clause will exist. AFG on track to reduce debt to $400m by June 2009.
• Centro Properties (CNP) has agreed to sell 29 of its 31 shopping malls in its wholesale Centro America fund for US$714m to pay back debt. Gives CNP a little space with its bankers while it works to sell assets to settle mounting debt to the tune of $6.6bn. It sold the assets at a 10% discount to their previous book value, which won’t help when they go to sell assets from their Australian wholesale fund. CNP up 22%.
• Babcock and Brown Infrastructure’s (BBI) analyst’s briefing highlights less than a 0.5% FY08 EBITDA impact from the Varanus Island gas supply crisis. WestNet Rail FY08 capax slightly above forecast. BBI flat. It was up 6% yesterday.
• Crown (CWN) hits a record low. Down 6% or 50c to 782c on fears for a global slowing in gaming expenditure, uncertainty over their acquisition intentions and hurdles for their Macau JV business put up by visa restrictions on mainland Chinese.
• Incitec Pivot (IPL) said its ammonium phosphate plant at Phosphate Hill has returned to normal operating conditions after essential repairs costing $49m in net profit. Up 2.93%.
• Leighton Holdings have announced a $130.6m contract from RIO. Share price down 4.39% or 200c to 4360c.
• Goldman Sachs ups aluminium price forecasts after a 10% cut in Chinese production.
• Bernanke gives his testimony on monetary policy to the Senate Banking committee tonight.

Where has the resources boom gone? I don’t mean the one driven by iron ore or coal, nor oil, but by surging demand from China, India and the rest of the emerging world? Warning bells are sounding in metals markets and there is every indication that even in China, there are some rough times ahead. The shares prices of some Australian producers are reflecting the emerging weakness. last week we reported on Fox Resources, a small Australian miner deferring work on copper and nickel prospects and mine. Power shortages and a looming oversupply of some metals and weakening prices make for interesting decision making for some companies, especially if they are in China. And when a weakening market price happens to emerge as this power crunch happens, China seems to act as one to try and modify the market weakness and correct the imbalance in power demand. Take aluminium: China has put a freeze on the use of power in some northern provinces because of a shortage of electricity and weak prices. That has seen China Aluminium (Chinalco) cut production at a couple of major smelters for an indefinite period as the provincial governments maintain power supplies for farming and urban use. The cuts saw world aluminium prices hit successive highs last week for the metal, as the prices of nickel, copper, lead zinc and other metals fell or remained static as other producers joined in the reductions. Three month aluminium in London last week peaked at $US3 350 a tonne, a rise of 10% over a couple of days as China’s 20 leading smelters said they would cut output by 5% to 10% from July to reduce power consumption. Analysts reckon the move is a short-term decision to free up electricity for the summer because demand has dropped and there’s not the need there for as much metal as previously thought. Analysts estimate the reduction in Chinese output will cut global aluminium supplies by 1.3 million tonnes or 3%, which will help support the weak metal price, which happened late last week. Chinalco, or the Aluminum Corp of China, the nation’s largest producer, was among 20 companies that signed an agreement to cut output by 5% to 10% which is aimed at shrinking the rapidly growing surplus of the metal around the world.

That surplus was estimated at 458,000 tonnes in the first four months of the year, according to a report from the World Bureau of Metal Statistics.

The question is now whether Australian, European, South African or Canadian producers (BHP Billiton, Rio Tinto or Alcoa) will follow suit). They don’t have to, but they can watch world prices rise and benefit.

And yesterday a similar situation for zinc and lead smelters in China, but one driven by weak prices and demand for both metals, not so much by power problems.

China is the world’s largest producer of the metals and the major processors agreed to cut output by 10% from July to September to reduce costs and help ease a power shortage.

29 producers met at the weekend to discuss the production cuts. The companies reportedly also suggested the Chinese government buy the metals when prices are close to cost and store as the country’s strategic reserves.

The Association also said in a statement that cuts were also to ensure sufficient electricity for the Beijing Olympics next month, it said.

Zinc and lead prices surged on Friday on hopes of the cuts would be agreed to over the weekend.

Up till last week zinc prices had fallen 15% this year so far and lead by 23%, thanks to excess supply and weakening demand.

Chinese analysts reckon the agreement was reached between smaller and medium sized producers and the big players haven’t agreed to the cuts and will continue to churn out metal top drive down prices and some of the competition out of business.

The moves make a mockery of warnings from interested parties (such as trade unions) of job losses here if Australia adopts a greenhouse control measure like a carbon tax and or emissions trading that are too costly.

To move a business like an alumina refinery or aluminium smelter offshore requires money, to build one in China or India, requires money and a power agreement as well.

Money is in short supply at the moment, and will be for some time: but power is in short supply in China, India, South Africa and a host of emerging economies which it is claimed, will snap up our jobs and our companies which can’t or don’t want to change to meet the new greenhouse emission rules.

China is supposed to be building 1 to 2 power stations every 10 days or so. Many of these stations are cleaner than the ones in Australia, and yet they can’t bridge the supply gap. Nor can Southern Africa.

China doesn’t want our smelters, nor does South Africa or other countries in the region (for at least the next five to six years), or Canada or Europe or Brazil. Brazil plans to build more based on bauxite and alumina resources it has, as does Saudi Arabia.

US mortgage giants, Fannie Mae and Freddie Mac are to be supported by the US Government to stop their possible collapse or a loss of confidence in them badly damaging the US housing sector,economy and financial system. In a dramatic statement at around 8 am this morning, Sydney time, US Treasury Secretary , Hank Paulson indicated he would seek blanket authority from the US Congress to aid the two struggling mortgage giants. The move came only hours before Freddie Mac had been due to sell $US3 billion worth of short-term debt, a move that would have seen if the market had wanted to support them.  It is now clear there was every opportunity that the issue would have failed, thereby questioning the credit worthiness of the USA itself because debt from the two mortgage groups is regarded as being tantamount to US sovereign debt. Paulson will ask the US Congress for a “temporary” increase of the companies’ lines of credit with the Treasury from the current $US2.25 billion each, and the right to buy equity “if needed.”  The plan, if it is given congressional approval, would give Paulson power to buy an unspecified amount of stock in Fannie Mae and Freddie Mac. A third element of the proposal would give the Federal Reserve a “consultative role” overseeing the companies’ capital requirements.  The Fed also announced it will let the companies borrow directly from the Fed at the same discount rate as commercial banks. The rescue and support package is similar to the way the Fed, Treasury and others bailed out Bear Stearns in March and stablised financial markets. US media reports had said over the weekend that the US Treasury would issue a statement of support for both groups this morning, before trading in Tokyo opens. There were reports in two News Corp papers on either side of the Atlantic of a possible support action from the US Government. The London Times reported that a $US15 billion injection of capital from the US Government was being considered among a list of possible options, while the Wall Street Journal reported on the weekend that a government support package could be announced Sunday night or early Monday in time to support the bond issue by Freddie Mac. The Journal reported that the US Government wanted to make sure the money helped the mortgage markets and not shareholders in both quasi-US groups.  The debt of the two mortgage giants is considered to be on the same ranking as the US Government debt in the minds of the market. So any problems with it could hurt the overall US debt markets. A move to buy the debt to be sold later tonight, by the Treasury or by the Fed, could send a support signal, like they did with the Bear Stearns rescue in March. That was started on a Thursday night and finished the following Sunday evening while 60 Minutes was airing in the US on CBS, but before the Tokyo stock market started trading Monday morning (Australia didn’t matter). Certainly Russia, which holds $US100 billion of US Government agency debts in its official reserves (including Freddie Mac and Fannie Mae) considers the agency debt as on a par with the debt of the US Government, according to a statement from the Russian Finance Ministry Friday and reported on Reuters. Other countries (China?) would have big holdings as well and they would not expecting a sharp rise in losses on that debt to the point where it raised questions about its backing. The Freddie Mac and Fannie Mae problems raise enormous questions about the credit worthiness of the US and there’s a geo-political side to the whole situation. The US can’t contemplate letting the two companies go broke: it would be tantamount to the US defaulting. Nor can the Bush Government or any government takeover over both mortgage groups: the $US5 trillion in dent would double the US national debt (but probably legitimise a grey area) and hurt the value of the dollar and trigger an enormous bout of financial instability.

Even though a takeover would see trillions in assets added to the US Government’s books, the markets would ignore that. It could see the US Government become the biggest loser from the subprime mess and credit crunch.

That they have gone half the way indicates how worried the uS is about the stability of the system, with Freddie and Fannie the focal points.

The fears about Freddie Mac and Fannie Mae is that they do not have enough capital to handle any sizeable loss in coming months or years from falling US house prices. Some commentators argue that if their mortgages were marked down to fair value (like many banks have to do), then they might not be solvent. 

Both groups said Friday they had enough capital but there were reports that Goldman Sachs was looking to raise money for one of the duo’s capital base and not new debt.

If the latest help proposals from the US Congress for struggling US homeowners facing foreclosure are to work then Fannie Mae and Freddie Mac will have to have robust capital bases because they will be required to play a major part in supporting the tottering US mortgage market.

US regulators (and the two firms themselves) say the duo have enough capital

“They are adequately capitalized, holding capital well in excess of” the requirements, the Office of Federal Housing Enterprise Oversight, said in a statement quoted on Bloomberg.” They have large liquidity portfolios, access to the debt market and over $1.5 trillion in unpledged assets.”

According to broking estimates, also quoted on Bloomberg, Fannie Mae and Freddie Mac would have to post pre-tax losses and write-downs of about $US77 billion before the US would be compelled to start a rescue. The companies have already raised $US20 billion to cover losses from the highest delinquency rates on housing in 30 years.

According to the two companies they lower interest rates on the 30-year fixed rate mortgages they guarantee, reducing the costs of home ownership for many Americans.

They buy mortgages from lenders and repackage them as securities for investors: this is securitization and it’s on the nose everywhere because of the credit crunch.

But in the US these companies are much more deeply involved in the housing finance sector because of their longevity and quasi-US Government status. They have a long history of securitising mortgages, even though bad times in the past. The home loan securitisation markets in countries like Australia and the UK are much younger and have less resilience. 

That’s why they have been shutdown by the credit crunch and the collapse or departure from the sector of leading players.

Fannie Mae and Freddie Mac provide lenders more funds to make further loans. Their automated underwriting systems have standardized mortgage lending and evened out regional US credit differences. They have become essential to the recycling of funds into US housing.

That’s why they have been caught by the credit crunch and subprime morass. Even though they are chartered by the US Congress, that didn’t prevent them from making many of the same mistakes that privately- owned funders did.

On top of that the two groups’ holdings of existing mortgages and securities are so large that they have continued to be battered by the 14-15% drop in US home prices in the past year.

That US Government charter, but private ownership, has placed them in a grey area of being neither wholly Government-owned, or wholly private: their shares trade on the New York Stock Exchange. That’s why they are called “Quasi-Government Sponsored Enterprises”

Their charters entitle them to $US2.5 billion lines of credit to the Treasury that each firm could draw on in an emergency, helping to add to the impression of government approval and support.

The US Government could very easily give them access to that line of credit, or merely increase it to show support.

This assumption by financial markets that the government would bail them out in a crisis means Fannie Mae and Freddie Mac can borrow more cheaply than purely private financial institutions.

At the same time, the companies are limited from lending directly to home buyers or from pursuing any other business line than mortgage finance. There are also upper limits to the size of mortgages they can buy.

Fannie Mae was originally called the Federal National Mortgage Association and was created in 1938 as part of a campaign to expand the US secondary mortgage market and boost homeownership as the country emerged from the Depression. The US Congress launched Freddie Mac, originally the Federal Home Loan Mortgage Corp, in 1970 to further expand home loan finance.

Stockmarkets are in for a very nervy week after the failure of two banks on Friday night: one in Denmark and one in the US and the worries about the future of the two giants of American mortgage finance, Fannie Mae and Freddie Mac. The support for the two US mortgage giants by the US Government and Fed, should help calm nerves today and allow the market to work out the impact and what happens next. Everything that happens this week will spring for just how much support the US Government can give to these two central figures in the US housing crisis. They control $US5 trillion of debt in various forms, have trillions in assets, and are simply too big to fail. The seizing of the failure of the IndyMac mortgage bank in California was the largest US bank failure for 15 years or more. It is in fact the second biggest failure in US history with losses estimated in preliminary reports up to $US8 billion.  There is around $1 billion in uninsured deposits: shareholder funds have been destroyed. It is going to further damage confidence in the huge Californian economy and housing market which is one of the worst affected from the subprime collapse. While Asian markets, including Australia finished higher on Friday, that will not be the case today as we’ll catch up to the very nervy trading Friday across Europe and the US. On top of these financial worries, oil hit a new high Friday in US trading and there were concerns about the health of a British financial conglomerate. Our optimism, which was driven by resource stocks, offset further weakness in banks on Friday. That will not persist today. The futures market was signalling a 1.5% drop here today after Wall Street fell by well over 1% on Friday night (the losses early on as Freddie Mac and Fannie Mae shares plunged in early trading, were more than double that). So it’s no wonder that the key global index, the MSCI World Index is now down 20% from its October record and nestling with the bears in Australia, parts of Asia, the US and Europe. The MSCI World Index tracks 1,742 companies in 23 developed markets, lost 1.4% on Friday. It fell 12% in the first half of the year (the steepest since 1982) and is now 20.3% off its October 31 high. The UK market became the eighth of the world’s 10 biggest equity markets to drop into a bear market since November. Markets in the US, Japan, China, France, Hong Kong, Germany and Australia have retreated more than 20% from their peaks because of the credit crunch, the US subprime mess and housing slump, rising inflation and more than $US400 billion in write-downs and losses from financial companies since the start of last year. During Friday’s roller-coaster session on Wall Street, the Dow dropped below the 11,000 level for the first time since July 2006. It trimmed that loss to close at 11,100.54. For the week, the Dow lost 1.4%, its fourth straight weekly decline; Nasdaq slipped 0.3% for the week, while the S&P 500 slid 1.9% into the arms of the bear. And American financial companies have led the slump into the bear market as the credit crunch, near recession and falling home values caused US homeowners to default on their mortgages. Leading bank, Wachovia Corp, Fannie Mae and investment bank, Lehman Brothers have lost 70% in value this year. UBS in Switzerland has been weak, as have Citigroup, the strong Australian banks, Bradford and Bingley, Barclays and UK home builders (along with their US counterparts).

Consumer companies (retailers, media companies, consumer durables, like groceries, car companies, home builders) are dependent on discretionary spending, which has taken a hammering in the US, Japan, Britain, Australia and Europe this year. 

That explains why the segment had the second-steepest decline among MSCI industries this year after financials. Rising inflation, high oil and petrol prices, plus surging food costs (and falling house prices) have hurt.

In Friday’s helter-skelter trading, all concerns about bear markets and international comparisons were moved to the sidelines as investors watched the shares in the two mortgage giants hammered, surge and then sold off again.

Fannie Mae tumbled 25% to $US9.98. Freddie Mac lost as much as 51% in early trading to $US3.89 before climbing back to $US7.20 in afternoon trading.

The rescue of IndyMac came late Friday afternoon in the US.

Lehman dropped 16% to $US14.47; Wachovia slumped 11% to $US11.75 and is had its biggest weekly decline in 25 years. It appointed a new CEO and reported a $US2.6 billion loss last week. It’s America’s 4th biggest commercial bank and home lender and it has been suffering because of the problems with subprime mortgages and the sharp fall in mortgage sales.

Freddie Mac is due to sell $US3 billion in debt Monday morning, US time: that will have to be supported, one way or another. An unsuccessful debt sale would imperil both groups.

We must remember that the Fed and US Treasury worked their rescue of Bear Stearns and its sale to JP Morgan on a Sunday, culminating in an announcement before trading started in Tokyo. This could be a similar situation today.

In Europe the Dow Jones Stoxx 600 Index fell to a three-year low and the London market entered a bear market.

The Stoxx 600 Index lost 2.7% to 270.36, the lowest since June 6, 2005. The index fell 3.3% last week, capping its sixth straight weekly drop.

Indexes retreated in all 18 western European markets except for Norway. France’s CAC 40 slid 3.1% and Germany’s DAX slipped 2.4%.

The FTSE 100 dropped 2.7%, pushing its slump from a June 2007 high to more than 20%. (Over 22%).

Rallies by commodity stocks have limited the drop in the UK. Seven of the top 10 stocks by market cap in London are resource stocks. In Australia its three, but we also have four banks and News Corp, all of which have been pounded in recent months.

That confidence won’t last today after the nervy trading in the US and Europe on Friday night.

The MSCI Asia-Pacific Index rose 0.4% on Friday. Japan’s Nikkei fell 0.2%, capping a fifth weekly decline. Most Asian benchmark indexes rose after the New York Times reported Friday that the US plan to bail out Freddie and Fannie. That story was later denied. China’s CSI 300 Index gained 7.7% last week ending a seven-week losing streak.

India’s Sensex 3.3% Friday but it still finished up for the first week in eight.