Agcapita Briefing
September 2009




                    1
Summary




Milton Friedman famously postulated “inflation is always and
everywhere a monetary phenomenon”. To believe in ...
Summary (continued)




Its important to remember that inflation is not incidental to what the governments and central ban...
Energy Update




ENERGY CONSUMPTION OVERVIEW

In inflation adjusted terms, oil is materially below its   attractive windo...
Energy Update (continued)




that are planned globally (about 230) out to 2015.        118 million barrels per day - 10.5...
Energy Update (continued)




WORLD OIL PEAK WHEN?

The global recession has temporarily hidden a                         ...
Energy Update (continued)




dormant storage sites have been reactivated. “At                 Average prices at the AECO ...
Energy Update (continued)




−   Households: Home appliances are the world’s           SASKATCHEWAN OIL QUICK FACTS
    f...
Energy Update (continued)




−   Crude oil production in 2007 was 24.8 million
    cubic meters (156.1 million barrels). ...
Agriculture Update




FOOD, FEED AND FUEL REVISITED

As the world’s population grows, competition for                    ...
Agriculture Update (continued)




SHORT HISTORY OF AGRICULTURE
                                                          ...
Global Macro Update




US FISCAL DEFICIT

The U.S. federal budget deficit will run to $1.6 trillion                      ...
Global Macro Update (continued)




If and when purchasers of US sovereign debt                                    GLOBAL ...
Global Macro Update (continued)




CANADIAN DOLLAR

Timothy Lane, one of the deputy governors of the         low interest...
Global Macro Update (continued)




While this inflationary program to save the banking        deliberately creating infla...
DISCLAIMER:

                                  The information, opinions, estimates, projections and other materials
     ...
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Investing in Agriculture - September Agcapita

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Investing in Agriculture - September Agcapita

  1. 1. Agcapita Briefing September 2009 1
  2. 2. Summary Milton Friedman famously postulated “inflation is always and everywhere a monetary phenomenon”. To believe in deflation is to believe that the money supply will actually contract rather than the rate of growth merely slowing from historically high levels which is all that is happening currently. Rather than contract, I believe that there are two factors that will significantly increase the money supply in the medium term: − Excess Bank Reserves: The global banking system has been flooded with cash that is currently accumulating on central bank balance sheets as “excess reserves”. Banks will obviously begin to lend again and through the multiplying effect of fractional reserve banking will significantly increase the money supply. If they do not do so voluntarily we expect them to come under government pressure to do so. I do not believe that the political will exists to extract these funds from the banking system. For example, the Swedish Central Bank recently cut nominal CONTENTS rates on excess reserves on deposit to NEGATIVE 0.25% 3 Energy Consumption Overview in order to force banks to lend. 3 Global Oil Production - WEO − Fiscal Deficits: Massive Keynesian style spending/deficits 4 Global Oil Production - EIA planned – current projections by the World Bank are that 5 World Oil Peak When? government deficits will accelerate to 9% of global GDP in 2009. 5 Alberta Natural Gas Government is stepping in as borrower and spender of last 6 Energy Consumption Quick Facts resort. 7 Rig Counts 7 Saskatchewan Oil Quick Facts Prior to 1971 when the US and the world went off the last remnant 9 Food, Feed and Fuel Revisited of the gold standard you could argue that there was at least some 10 Short History of Agriculture restraint on printing money. We have now arrived at a point in 11 US Fiscal Deficit financial history where there appears to be no immediate restraint 12 Global Interest Rates on money printing compounded by the fact that there is no stable 13 Canadian Dollar (non-inflating) fiat currency with sufficient market size to act as a safe 13 Global Money Printing Update haven/competition and widespread belief amongst governments and central banks that inflation will actually be a good thing for the economy. The track record of the central banking community with respect to inflation/eroding the purchasing power of fiat currency is virtually perfect. The economist, Ludwig Von Mises once quipped “Government is the only institution that can take a valuable commodity like paper, and make it worthless by applying ink.” 1
  3. 3. Summary (continued) Its important to remember that inflation is not incidental to what the governments and central banks of the world have been doing during the crisis. They’re not saying, “Let’s bail out the banking system even if that is inflationary.” The banking system has been flooded with excess reserves with the expectation that these will be lent and the money supply increased. I would argue that the banking system is incentivized to create leverage and lending and so I can’t see that all this money sits on the sidelines indefinitely. On top of the excess reserves parked in the system, the governments of the world are now effectively dictating that if the private sector will not or cannot borrow the reserves they have pushed into the banking system then they will borrow them. Hence we have fiscal deficits rapidly increasing across the globe. Canada is not immune from this type of inflationary activity. Timothy Lane, one of the deputy governors of the Bank of Canada has been floating the idea that the Bank of Canada should use quantitative easing to devalue the Canadian dollar. Mr. Lane said that a “persistently strong” Canadian dollar will reduce growth. However, quantitative easing would merely lower the purchasing power of Canadians through inflation as it devalued the Canadian dollar – where’s the benefit? Does the Bank of Canada really believe you can devalue your way to prosperity? Ask any inflation stricken country about this theory. I believe that current Keynesian policies will achieve nothing more than corrosive inflation. What western economies need is more capital. Printing money does not create capital. Worse yet, low interest rates artificially stimulate speculation and consumption rather than savings. Ultimately, the inflation that money printing creates reduces the pool of available capital causing long lasting harm. There are lots of complicated and opaque terms for what is being done - quantitative easing, liquidity, stimulus, bail-outs etc - but strip away the jargon and its simply printing money, borrowing money and spending money. If Milton Friedman, Ludwig Von Mises and history are any guide it should be inflationary. On a different note we have added an energy section to the briefing for three key reasons: − Energy and agriculture are increasingly intertwined with the expanding production of biofuels and large energy inputs required to maintain the yields in modern agriculture. − Western Canadian oil production assets were being sold for over $70,000 per flowing barrel in late 2007, early 2008. Purchase prices have now fallen to around $20,000 per flowing barrel and less due to the credit crisis. At current oil prices, direct production purchases can generate extremely attractive cash flows for discriminating investors. − The energy sector is part of the western Canadian secular bull market for commodities that is one of Agcapita’s central investment beliefs. Kind Regards Stephen Johnston - Partner 2
  4. 4. Energy Update ENERGY CONSUMPTION OVERVIEW In inflation adjusted terms, oil is materially below its attractive window of opportunity to purchase oil and 1981 peak. The current oil markets, however, are gas assets for competitive prices. dramatically different from their 1980s counterparts. In 1981: GLOBAL OIL PRODUCTION - WEO − Global consumption was approximately 69 million bopd In 2008 World Energy Outlook (“WEO”) analyzed − OPEC had approximately 10 million of spare approximately 800 fields accounting for ¾ of global production capacity reserves and more than 2/3 of global oil production. − Global production was increasing approximately They came to the conclusion that decline rates are far 1% per annum higher than previously thought, between 6.7% and − China consumed less than 2 million bopd or less 8.6% a year. As result, they estimate that to maintain than 1 barrel/person/year the current levels of oil production by 2030 the world − The US consumed 24 barrels/year/person would need to develop and produce 45 million barrels per day or approximately four new Saudi-Arabias. In 2008: Simultaneously, they analyzed the large-scale projects − Global consumption is approximately 84 million bopd − OPEC is estimated to have less than 3 million of spare production capacity CHART 1: WORLD CRUDE OIL & LEASE − Global production outside of OPEC is declining by CONDENSATE PRODUCTION, over 5% per annum INCLUDING CANADA OIL SANDS − Data points to global peak oil underway MBD − China is the second largest consumer of oil in 76 Forecast the world – 8 million bopd but still only 2 barrels/ IEA WEO 2008 person/year 72 Decline rate = 3.4% pa Peak 1 Peak 2 Peak 3 − The US consumes 24 barrels/year/person May 05 Dec 05 Jul 08 74.82 Dec 2010 to Dec 2012 74.24 74.16 68 May 09 Alberta and Saskatchewan have non-conventional oil 70.8 reserves that rival Saudi Arabia – and conventional 64 reserves of oil and gas that make them world-class producers. Oil production in Alberta was being sold 60 for as much as $130,000 per flowing barrel in late 56 2007, early 2008. Purchase prices have now fallen to 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 under $20,000 per flowing barrel. Junior producers are in extreme distress due to an inability to access Source: EIA, en.wikipedia.org/wiki/Oil_Megaprojects, Tony either the debt or equity markets. This presents an Eriksen “ace” theoildrum.com 3
  5. 5. Energy Update (continued) that are planned globally (about 230) out to 2015. 118 million barrels per day - 10.5 million barrels of It takes five to ten years to produce oil from a new unconventional liquids filled the shortfall. In 2009 field. When the WEO added all the projects together the numbers deteriorated materially. Projected (assuming all of them are able to locate financing conventional production dropped from 107.5 million in the current credit crunch) they will bring about barrels per day of oil in 2030 in 2007, to 102.9 million 25 million barrels per day. However, because of barrels per day in 2008, to 93.1 million barrels per the decline rates, the world will still be short of “at day in 2009. That’s a 13.4% reduction in conventional least” 12.5 million barrels per day before 2015. A production in two years. recent report from the US Joint Forces Command supports the WEO calculations: “By 2012, surplus The 2009 EIA report assumed 13.5 million barrels oil production capacity could entirely disappear, and per day of unconventional liquids by 2030 to fill the as early as 2015, the shortfall in output could reach supply shortfall, including 5.9 million barrels per day nearly 10 million barrels per day.” in biofuels. To reach 5.9 million barrels per day of biofuels by 2030 would necessitate a huge diversion In 2009, Merrill Lynch also conducted a similar of cropland from food to energy with the strong analysis and concluded that, “the world now needed possibility of increasing food prices and shortages. to replace an amount of oil output equivalent to Saudi Arabia’s production every two years”. Yet The EIA reference case calls for USD$130/barrel oil oil production is already in an irreversible decline in 2030. Assuming inflation rates of 5% over the in at least 54 of the 65 most important producing projection period then this is only USD$ 46/barrel countries and we currently consume between in real terms – i.e. the unlikely conclusion that real 4-5 barrels of oil for a single one discovered; an prices in 2030 will be lower than exist currently. Both unsustainable situation. inflation and demand growth could be much greater and according to other research the cost of oil could GLOBAL OIL PRODUCTION - EIA pass the USD$300/barrel mark if there is even a 15% shortfall in the supply. At a recent meeting of the All The Energy Information Administration (“EIA”) Party Parliamentary Group on Peak Oil, Toronto- publishes an annual International Energy Outlook. based transport consultant Richard Gilbert revealed Up until 2008, they were predicting growth in world that while oil consumption is expected to increase by oil supplies for the next two decades. The EIA makes about a third by 2025 to more than 40 billion barrels its projections based on what its analysts call the a year, production will have fallen to less than 25 “reference case” that is tied to an estimate of average billion barrels a year. Gilbert quoted two different economic growth. sets of research, highlighting the impact of a shortfall in crude supply: one states that a 15% shortfall in In 2007 the EIA was predicting that world production supply will lead to a 550% hike in the cost of a barrel of conventional liquids would be 107.5 million of crude (and that’s based on the 2002 price of barrels per day in 2030 (up from 81.9 in 2005) USD$50/barrel) and the other concludes that a 4% coinciding with its prediction for world demand of shortfall will result in a 177% increase. 4
  6. 6. Energy Update (continued) WORLD OIL PEAK WHEN? The global recession has temporarily hidden a World oil discovery peaked in mid 1960s. Since the developing problem in the energy sector. As more oil production in the lower 48 states of US peaked and more countries are reaching their national peak about 40 years after the peaking of discovery, there oil outputs, the obvious question is when will world oil are reasons to believe according to Hubbert’s theory production peak. The concept that oil production will the same thing could happen to world oil production. peak is not in dispute – rather the timing of this event. Predictions vary from it already having taken place to ALBERTA NATURAL GAS 2030 and beyond. Peak oil was first studied by M. King Hubbert. In 1956, he successfully predicted the The Alberta economy is heavily exposed to natural 1971 US oil production peak by using a model based gas prices rather than oil prices. While oil prices on cumulative oil discoveries, predicting it appears have been relatively strong, natural gas prices in correctly, that oil production follows oil discoveries Canada are at lows not seen since 2002. According in the same bell shaped curve. To put current to First Energy “The market is trying to rationalize all discoveries in perspective to current consumption - of the gas that is piling up and there are fewer and oil is now being consumed four to five times faster fewer places to put it. We expect that a $1 handle on than it is being discovered. prices will start becoming more common in the next few weeks,” said First Energy analyst Martin King. Inventory levels continue to build in Western Canada, at 492.46 billion cubic feet as of Aug. 23 2009. This CHART 2: WORLD OIL DISCOVERY OVER exceeds the 489 billion cubic feet of existing storage 10-YEAR PERIODS capacity that according to King indicate that some 500 450 400 CHART 3: US NATURAL GAS STORAGE TREND Billions of Barrels 350 300 250 3,600 3,200 200 2,800 Billion Cubic Feet 150 2,400 100 2,000 50 1,600 1,200 0 800 1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 2010 2020 2030 400 Discovery Extrapolation 0 May-08 May-09 Aug-07 Nov-07 Aug-08 Nov-08 Aug-09 Feb-08 Feb-09 Source: ASPO March 2008 5
  7. 7. Energy Update (continued) dormant storage sites have been reactivated. “At Average prices at the AECO natural gas hub in this stage, we still believe that shut-ins on the scale Alberta dipped below CAD$2 recently. Natural gas of 0.5 billion to 0.8 billion cubic feet per day may be prices have been on a downward spiral since the needed for a short period of time for some kind of middle of 2008, driven by increased North American balance to be achieved in this market. If this does supply. The effect of this divergence between strong not occur, then protracted extreme price weakness is oil prices and weak natural gas prices can be seen likely in store for the middle to late part of September graphically in Chart 4 of the ratio between the two. to prices below $1 per gigajoule.” Storage levels are The oil/natural gas ratio is now trading at levels not also high in the US as can be seen in Chart 3 seen in two decades. ENERGY CONSUMPTION QUICK FACTS − Internet: Contrary to popular belief, the internet CHART 4: WTI CRUDE VERSUS NATURAL consumes large amounts of energy. Author John GAS RATIO (AUGUST 2009) Michael Greer explains: “The hardware of the (CLV9/NGV9) 8/1/2009 internet, with its worldwide connections, its vast 24.14 server farms, and its billions of interlinked home 23.00 and business computers, probably counts as 22.00 the largest infrastructure project ever created 21.00 20.00 and deployed in a two decade period in history. 19.00 The sheer amount of energy that’s been invested 18.00 to create and sustain the internet beggars the 17.00 16.00 imagination.” Recent estimates indicate the 15.00 infrastructure necessary to support the internet 14.00 consumes 10% of all the electricity produced in 13.00 12.00 the United States and 5% globally. 11.00 − Automobiles: The construction of an average car 10.00 consumes the energy equivalent of approximately 9.00 20 barrels (840 gallons) of oil. Ultimately, the 2004 2005 2006 2007 2008 2009 Monthly construction of a car will consume an amount Note: The shaded area indicates the range between of fossil fuels equivalent to twice the car’s the historical minimum and maximum values for the final weight. It’s also worth noting that the weekly series from 2004 through 2008. Source: construction of an average car consumes almost Form EIA-912, “Weekly Underground Natural Gas 120,000 gallons of fresh water. Storage Report.” 6
  8. 8. Energy Update (continued) − Households: Home appliances are the world’s SASKATCHEWAN OIL QUICK FACTS fastest-growing energy consumers after automobiles, accounting for 30 percent of − Saskatchewan’s first commercial crude oil industrial countries’ electricity consumption. discovery was made in 1944. Ninety percent of the energy consumed by an − Most of the major pools were discovered as a incandescent light bulb is given off as heat, while result of an intensive exploration effort in the mid- only 10 percent is converted to light. 1950s and early 1960s. − Saskatchewan is now the second largest oil producer in Canada after Alberta producing RIG COUNTS approximately 17 percent of total Canadian oil Baker Hughes has issued the rotary rig counts as a production. service to the petroleum industry since 1944, when Hughes Tool Company began weekly counts of US and Canadian drilling activity. Recent counts show a CHART 6 massive drop-off in activity in the oil and gas sector, particularly in North America. When the economy and demand starts to grow again this period of limited investment into production and development may create upward pressure on prices. ALBERTA SASKATCHEWAN MANITOBA CHART 5: RIG COUNTS Change Last Count Area Count from Last Date Year U.S. August 999 -1032 NORTH DAKOTA Canada August 184 -252 MONTANA International July 974 -118 SOUTH DAKOTA Source: Baker Hughes WYOMING 7
  9. 9. Energy Update (continued) − Crude oil production in 2007 was 24.8 million cubic meters (156.1 million barrels). CHART 7: BAKKEN OIL PRODUCTION − Cumulative oil production from Saskatchewan Well Oil Production to December 31, 2007 was 745.0 million cubic Count Per Well OIl Production meters (4.7 billion barrels). 700 70 − Remaining recoverable reserves at December 31, 600 60 2006 were estimated to be approximately 187.5 Oil Production per Well million cubic meters (1.2 billion barrels). 500 50 − Saskatchewan has an estimated 3.4 billion cubic meters (21.3 billion barrels) of heavy oil-in- place 400 40 in the west-central region of the province. 300 30 − Saskatchewan set a record for land sale revenues of $1.12 billion in 2008, of which $916.5 million 200 20 was spent in the southeast in the Bakken play. Well Count 100 10 − The Bakken formation — a light oil-bearing Oil Production formation extending throughout the Williston 0 0 Basin — is estimated to contain anywhere from 2003 2004 2005 2006 2007 2008 100 billion to 400 billion barrels of oil in place, Source: Government of Saskatchewan one quarter of which is estimated to be located in Saskatchewan. − Production from Saskatchewan’s portion of the Bakken has jumped from 950 barrels of oil per day (bopd) in October 2004 to 54,000 bopd in October 2008. As of December 2008, Bakken production exceeded 57,000 bopd. − Saskatchewan’s oil production has steadily increased in the last eight years, after doubling between 1990 and 2000. By contrast, Alberta’s conventional (non-oilsands) production has steadily declined from 350 million barrels in 1995 to 191.6 million barrels in 2007. 8
  10. 10. Agriculture Update FOOD, FEED AND FUEL REVISITED As the world’s population grows, competition for water and energy. But Beddington also points to food, water and energy will increase. Food and other drivers. farmland prices will rise as a result. − Urbanization: Not only is the world’s population predicted to grow (until the middle of the century, According to John Beddington, the UK government’s at least) but more people are moving to cities. The chief scientific adviser, by 2030 “a whole series of growth of cities will accelerate the depletion of events come together” to create the pre-conditions water resources as cities are more water intensive for a crisis: per capita. − Income Growth: As people become wealthier − The world’s population will increase by 33% their diets are change. The largest increase − Demand for food will increase by 50% in meat consumption comes at income move − Demand for water will increase by 30% up to USD$ 5,000 per year – a change that − Demand for energy will increase by 50% approximately 80% of the worlds population has yet to make. Some of the problems reinforce each other, for − Biofuels: The more land is devoted to growing example, agriculture consumes large amounts of biofuels the less can be used for growing food. CHART 8: POPULATION GROWTH, 1950-2050 CHART 9: PROJECTED GROWTH IN FOOD PRODUCTION , 1960-2050 Europe Africa Asia Latin America Northern America Oceania Billion Million tonnes Total cereals Total meats 3500 10 Projected beyond 2008 Projected data 3000 8 2500 6 2000 4 1500 2 1000 0 500 50 55 60 65 70 75 80 85 90 95 00 05 10 15 20 25 30 35 40 45 50 19 19 19 19 19 19 19 19 19 19 20 20 20 20 20 20 20 20 20 20 20 0 1662 1970 1980 1990 2000 2015 2030 2050 Source: UN Source: FAO 9
  11. 11. Agriculture Update (continued) SHORT HISTORY OF AGRICULTURE CHART 10: GLOBAL ENERGY DEMAND The history of modern agriculture comprises three 1980 – 2030 distinct periods: Developed nations (OECD) Developing nations (non-OECD) World* − The Expansion Period (1600 to 1920): Increases Million tonnes of oil equivalent in food production during these three centuries 20 Projected from 2007 came simply from putting more land into 15 production; technological change played only a minor role. 10 − The Mechanization Period (1920 to 1970): In this half-century, technological advances issuing 5 from cheap, abundant fossil-fuel energy resulted 2005: Developing nations in a dramatic increase in productivity (output 0 overtake developed nations per worker hour). Meanwhile, farm machinery, 1980 1990 2000 2010 2020 2030 pesticides, herbicides, irrigation, new hybrid Source: IEA crops, and synthetic fertilizers allowed for the doubling and tripling of crop production. Also during this time, U.S. Department of Agriculture policy began favoring larger farms (the average U.S. farm size grew from 100 acres in 1930 to almost 500 acres by 1990), and production for export. − The Energy Period (1970-present): In recent decades, yield improvements have been primarily obtained with the application of increasing amounts of energy. At the same time the incremental productivity of this approach has been dropping – i.e. an ever-growing amount of energy is being expended to produce each extra bushel of yield from the overall system. In short, strategies that had recently produced dramatic increases in productivity became subject to the law of diminishing returns. 10
  12. 12. Global Macro Update US FISCAL DEFICIT The U.S. federal budget deficit will run to $1.6 trillion our national debt is now $340 billion. This is about this year, the Congressional Budget Office said at 3.04% rate of interest. In ten years the Obama yesterday, equal to 11.2% of GDP. That’s the biggest administration admits that they will add $9 trillion to deficit since World War II. This is a pattern that is the national debt. That would take it to $20 trillion. being repeated throughout the developed world – Let’s say that by some miracle the interest on the e.g. Britain will run a 11.6% deficit, and Japan a national debt in 10 years will still be 3.09%. That 10.3% deficit. would mean that the interest on the national debt would be $618 billion a year or over one billion a day. US government spending has climbed by US$700 No nation can hold up in the face of those kinds of billion, a 24 percent jump, for the biggest annual expenses. Either the dollar would collapse or interest increase in more than half a decade. It is expected rates would go through the roof.” to aggregate to US$ 9 trillion in the next 10 years – a doubling of debt levels as can be seen in Chart 12. As the current and cumulative US fiscal deficit grows the influence of the US’ creditors increases - the Richard Russell recently wrote, “The US national majority of these creditors are foreign, most notably debt is now over $11 trillion dollars. The interest on China. CHART 11: TOTAL CREDIT MARKET DEBT AS CHART 12: US NATIONAL DEBT AS PERCENT OF US GDP PERCENT OF GDP 370 350 3/31/2009 Debt = $52.904 Trillion = 375.5% 340 3/31/2009 GDP = $14.090 Trillion 100% 330 320 310 82% 300 290 280 270 80% 260 250 240 230 220 210 200 60% 190 180 170 160 41% 150 140 130 40% 2008 2019 1925 1930 1935 1940 1945 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 Source: Ned Davis Research Source: CBO 11
  13. 13. Global Macro Update (continued) If and when purchasers of US sovereign debt GLOBAL INTEREST RATES become concerned about US debt levels they may pare back or even exit the market altogether raising The major central banks of the world are continuing interest rates. According to tax policy expert and to pursue the strategy of monetary easing via Syracuse University professor Len Burman wrote in historically low interest rates and quantitative easing. a recent op-ed titled “Catastrophic Budget Failure”. ”Taxes would rise to levels that would make a There’s no sign yet that the US Fed will deviate Scandinavian revolt. And the government would not from the strategy it has been pursuing for almost a be able to provide anything but the most basic public year by making money virtually costless in nominal services. We would no longer be a great power (or terms. Paul McCulley, who helps oversee the world’s even a mediocre one), and the social safety net would biggest bond funds as a partner at Pacific Investment evaporate.” Management Co., expects the Fed will keep its target interest rate unchanged at zero to 0.25 percent into 2011. CHART 13: CHINA – AMERICA’S BANKER CHART 14: GLOBAL INTEREST RATES Quarterly figures, $bn Holdings of US assets, $bn 250 800 Increase in foreign- 200 Interest Rate (August exchange reserves* Treasury bonds Central Bank 150 600 2009) 100 Bank of Canada 0.25% 50 400 +0 Government Bank of England 0.5% -50 agency bonds 200 Bank of Japan 0.1% “Hot-money” flows Corporate bonds Equities+ 100 European Central Bank 1% 150 0 2004 05 06 07 08 09 2007 08 09 Federal Reserve 0.25% Swiss National Bank 0.25% * Includes PBOC’s other foreign assets, CIC, and foreign assets of state banks; adjusted for currency gains/losses The Reserve Bank of Australia 3% +Not marked to market Source: Brad Setser & Arpana Pandey, Council on Foreign Relations 12
  14. 14. Global Macro Update (continued) CANADIAN DOLLAR Timothy Lane, one of the deputy governors of the low interest rates (as can be seen in part from Chart Bank of Canada (“BOC”) has been floating the idea 14) and direct money printing in the form of the that the Bank of Canada should use quantitative suitably obscure title of quantitative easing (“QE”). easing to devalue the Canadian dollar. Mr. Lane said that a “persistently strong” Canadian dollar would The money injected into the financial system is what’s reduce growth. He attributed the Canadian dollar’s known in the central banking community as “high- increase to the recovery of commodities prices and powered liquidity” as its effect is multiplied greatly the weakening of the U.S. dollar - neither of which by the fractional reserve banking system. These the BOC has any direct control over. Quantitative funds are designed to re-inflate the asset markets easing, a direct money-printing strategy would lower – particularly it is hoped the stock and real-estate the purchasing power of Canadians through inflation markets. Sample QE programs: as it devalued the Canadian dollar. Does the BOC really believe you can devalue your way to prosperity? − Federal Reserve: The Fed is printing US$1.75- Ask any inflation stricken country about this theory. trillion in order to buy Treasury and mortgage Keynesian deficit and money printing economic backed bonds. policies are now being pursued globally on a scale − Japan: The Bank of Japan is printing ¥1.8-trillion without precedent. We believe that this will achieve each month into the banking system - monetizing nothing more than inflation. What western economies 50% of Tokyo’s budget deficit this year. need is more capital. Printing money does not create − UK: The Bank of England is printing £175-billion capital. Worse yet low interest rates and cheap pounds to purchase distressed assets from banks capital artificially stimulate speculation rather than – monetizing 66% of the UK’s budget deficit this saving and the inflation that money printing creates year ultimately reduces the pool of available capital − EU: The European Central Bank is printing causing long lasting harm. €442-billion (US$613-billion) which it will inject into one-year money-market funds. GLOBAL MONEY PRINTING UPDATE Our prediction is that this re-inflation effort will initially The global cost of bailing out the financial sector to only serve to increase the nominal price of speculative date amounts to around US$12-trillion. To put that assets – those that are directly accessible by the in perspective it represents approximately one fifth investment and commercial banking community while of the world’s total annual economic output. On having little effect on the real economy. Eventually top of this overt subsidy to the financial sector, the it will spread through the real economy creating G-20 governments are now committed to additional significant consumer price inflation. stimulus in the form of deficit spending, historically 13
  15. 15. Global Macro Update (continued) While this inflationary program to save the banking deliberately creating inflation but trying to keep the sector has been underway in the developed world, US’s increasingly restive foreign creditors happy at China has been selling US dollar to increase its the same time. Ultimately, I believe this will prove to inventories of oil, metals, and other industrial staples be a very difficult task. and making direct investments in natural resource assets from Canada to Australia to secure supply. In summary, I would argue that the large increase For example year on year China’s imports of: in the money supply that has taken place and that is planned will only serve to devalue the G-20 − copper were up 160%; and currencies and will not save the real economy – − aluminum were up 1,600%. perhaps the devaluation will not be obvious relative the various currencies as they all are debased at the As we wrote in the August briefing, in the first eight same rate but should become increasingly obvious months of 2009, China’s vehicle sales have for the versus hard assets. first time exceeded the US – increasing 29% to 8.33-million, while US vehicle sales decreased 28% to 7.1-million. Increased Chinese demand for iron- ore, steel, and rubber reflect this trend. I would argue that gold and crude oil prices clearly reflect the G-20’s inflationary monetary policies – in particular manifested by an increasingly weaker US- dollar. The consensus seems to be building that the G-20 central bankers will not be increasing real interest rates or reversing their QE in the near-term. The Fed is explicitly signaling that it intends to leave monetary policy extremely accommodative for an extended period while at the same time paying lip service to inflation fighting and the much discussed “exit”. What are we supposed to make of Fed Chairman Ben Bernanke comments in July that “The Fed believes that a highly accommodative stance of monetary policy will be appropriate for an extended period,” while at the same time declaring “We will not allow the broad measures of money circulating in the economy to accelerate at a rapid rate that would eventually cause inflation.” This seems somewhat contradictory to me and indicative of a man who is 14
  16. 16. DISCLAIMER: The information, opinions, estimates, projections and other materials contained here in are provided as the date hereof and are subject to change without notice. Some of the information, opinions, estimates, projections and other materials contained herein have been obtained from numerous sources and Agcapita Partners LP (“AGCAPITA”) and its affiliates make every effort to ensure that the contents hereof have been compiled or derived from sources believed to be reliable and to contain information and opinions which are accurate and complete. However, neither AGCAPITA nor its affiliates have independently verified or make any representation or warranty, express or implied, in respect thereof, take no responsibility for any errors and omissions which maybe contained herein or accept any liability whatsoever for any loss arising from any use of or reliance on the information, opinions, estimates, projections and other materials contained herein whether relied upon by the recipient or user or any other third party (including, without limitation, any customer of the recipient or user). Information may be available to AGCAPITA and/or its affiliates that is not reflected herein. The information, opinions, estimates, projections and other materials contained herein are not to be construed as an offer to sell, a solicitation for or an offer to buy, any products or services referenced herein (including, without limitation, any commodities, securities or other financial instruments), nor shall such information, opinions, estimates, projections and other materials be considered as investment advice or as a recommendation to enter into any transaction. Additional information is available by contacting AGCAPITA or its relevant affiliate directly. #400, 2424 4th Street SW Tel: +1.403.218.6506 www.agcapita.com Calgary, Alberta T2S 2T4 Fax: +1.403.266.1541 Canada

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