The End of “Business as Usual”

In my interview for Real Vision earlier this month, (where the world’s most successful investors share their thoughts on the markets and the biggest investment themes), I look at what data from the global chemical industry is telling us about the outlook for the global economy and suggest it could be set for a downturn.

“We look at the world and the world economy through the lens of the chemical industry. Why do we do that? Because the chemical industry is the third largest industry in the world after energy and agriculture. It gets into every corner of the world. Everything in the room which you’ll be watching this interview is going to have chemicals in it. And the great thing is, we have very good, almost real time data on what’s happening.

“Our friends at the American Chemistry Council have data going back on production and capacity utilization since 1987. So 30 years of data, and we get that within 6 to 8 weeks of the end of the month. So whereas, if you look at IMF data, you’re just looking at history, we’re looking at this is what’s actually going on as of today.

“We look, obviously, upstream, as we would call it, at the oil and feedstocks markets, so we understand what’s happening in that area. But we also– because the chemical industry is in the middle of the value chain, you have to be like Janus. You have to look up and down at the same time, otherwise one of these big boys catches you out.

“And so we look downstream. And we particularly look at autos, at housing, and electronics, because those are the big three applications. And of course, they’re pretty big for investors as well. So we see the relative balance between what’s happening upstream, what’s  happening downstream, where is demand going, and then we see what’s happening in the middle of that chain, because that’s where we’re getting our data from.

“As the chart shows, our data matches pretty well to IMF data. It shows changes in capacity utilization, which is our core measurement. If if you go back and plot that against history from the IMF, there is very, very good correlation. So what we’re seeing at the moment– and really, we’ve been seeing this since we did the last interview in November— is a pretty continuous downturn.

“One would have hoped, when we talked in November, we were talking about the idea that things have definitely cooled off. Some of that was partly due to the oil price coming down. Some of that was due to end of year destocking. Some of that was due to worries about trade policy. Lots of different things, but you would normally expect the first quarter to be fairly strong.

“The reason for this is that the first quarter– this year, particularly– was completely free of holidays.  Easter was late, so there was nothing to interrupt you there. There was the usual Lunar New Year in China, but that always happens, so there’s nothing unusual about that.

And normally what happens is, that in the beginning of the new year, people restock. They’ve got their stock down in December for year end purposes, year end tax purposes, now they restock again. And of course, they build stock because the construction season is coming along in the spring and people tend to buy more cars in that period, and electronics, and so on.

“So everything in the first quarter was very positive. And one wouldn’t normally be surprised to start seeing stock outs in the industry, particularly after a quiet period in the fourth quarter. And unfortunately, we haven’t seen any of that. We’ve seen– and this is worth thinking about for a moment– we’ve seen a 25% rise in the oil price because of the OPEC Russia deal, but until very recently we haven’t seen the normal stock build that goes along with that.”


As we note in this month’s pH Report, however, this picture is now finally changing as concern mounts over oil market developments – where unplanned outages in Venezuela and elsewhere are adding to the existing cutbacks by the OPEC+ countries. Apparent demand is therefore now increasing as buyers build precautionary inventory against the risk of supply disruption and the accompanying threat of higher prices.

In turn, this is helping to support a return of the divergence between developments in the real economy and financial markets, as the rise in apparent demand can easily be mistaken for real demand. The divergence is also being supported by commentary from western central banks.  This month’s IMF meeting finally confirmed the slowdown that has been flagged by the chemical industry since October, but also claimed that easier central bank policies were already removing the threat of a recession.

We naturally want to hope that the IMF is right. But history instead suggests that periods of inventory-build are quickly reversed once oil market concerns abate.

Please click here if you would like to see the full interview.

A day in the life of an “activist” fund

ManhattanDow rightA prominent “activist” fund in New York has told Dow Chemical to spin off its performance plastics, performance materials and feedstocks-and-energy units.  The news led the blog to imagine a fictional scene in the offices of Activists-R-Us fund last Tuesday morning, as the news came through.  Any resemblance to actual events is purely coincidental, as they say in movies.

Activists-R-Us Fund Owner:  Morning boys, and Happy New Year to me.  How are we going to make buckets of money in 2014?  What have you got for me?
Activists-R-Us Fund Managers.  Good morning, sir, and Happy New Year to you.  Hope you enjoyed the extended Caribbean cruise in your new yacht, sir.
Owner:  There were some yachts in the harbour with a landing pad for helicopters.  I need one of those.
Managers:  We had a call this morning about a company called Dow Chemical, sir, and we’ve been researching it.
Owner:  “Chemical”, comical, what’s that?  What does it do?
Managers:  We’ve been researching it, sir, before you arrived.  Its in Wikipedia and seems to make plastics, sir.
Owner:  Plastics?  Oh, yeah, I know plastics.  That’s the movie with Dustin Hoffman, isn’t it?  The Graduate.  “Go into plastics” they told him.  Well, if its good enough for Dustin, its good enough for me.  What’s the story?
Managers:  It seems their plastics business has been making buckets of money out of this shale gas thing that people have been finding everywhere. They somehow turn it into plastics.  We haven’t quite worked out that bit, yet.  But the numbers look good according to the Wall Street Journal.  Over $28bn revenue in the first 9 months.
Owner:  So what about the call you got on it?
Managers:  Well, it seems the grapevine thinks we should all be going after them.  You know, the usual spin-out story.  Give us the money now, or we blow your brains to bits.
Owner:  Sounds good to me.  How much are we talking?
Managers:  The share price was down at $7 in March 2009, and now its $45 this morning.  Management seems to have done a great job.  Boss on a presidential working party, everything you’d want for credibility.  So there’s plenty of cash there for us to target.
Owner:  Okay, boys.  Call your friend back and tell him that we’re in for the ride.
Managers:  Got it, sir.
Owner:  And remember, when this little beauty delivers, its treble bonuses for all you.  That new apartment in midtown Manhattan that your wife wants, along the block from here, you’ll get it.
Managers:  Thank you, sir!

US polyethylene and PVC exporters focus on margin, not volume

D'turn 30Nov13

2013 has seen 3 types of markets develop for the blog’s IeC Downturn Monitor portfolio as the chart above shows:

  • Financial assets such as the S&P 500 (purple) have soared, as did the US$ against the yen (orange)
  • Crude oil (blue) and naphtha (black) tried to follow, but found it difficult to pass though the higher prices
  • Benzene (green) and PTA (red) have struggled with weak demand and high feedstock prices

The anomaly has been US polyethylene (yellow), where prices have stayed relatively strong as producers chose to focus on margin rather than volume.

US PE, PVC Dec13aThis might seem a strange decision, given they enjoy a major feedstock cost advantage on ethylene due to shale gas.  But it makes perfect sense when seen against the limited potential for selling additional export volumes.  As the charts above show, based on trade data from Global Trade Information Services, there is really little scope for selling more PE or PVC (the main derivatives):

  • Total PE net volumes are up 16% (blue column) versus 2011 (red) this year due mainly to a 26% increase to Latin America
  • This region now takes three quarters of US net exports, as the percentage of sales to Asia has halved
  • Total PVC net sales are up just 7% this year versus 2011, and flat versus 2012 (green)
  • Exports are focused on Turkey, Mexico, Russia and Egypt: Asian volumes have also dropped versus 2011-12

This message does not yet seem to have got home to investors.  They look at the raw data, and see just rising volumes and high margins.  So they imagine that the world, and Asia in particular, are just waiting for additional volumes to appear.

What they miss is that Asian and LatAm countries are busy expanding their own production as fast as possible, so as to create jobs.  They also forget that China’s slowdown is also now impacting Latin America’s demand.  Equally, they overlook the fact that Brazil’s vast increase in PVC imports (double 2011 levels) and in PE (up 34%), is mostly a one-off bonus due to preparations for the soccer World Cup and the Olympics.

The operating managers with whom the blog talks understand all this very well.  Some have special grades of PE that currently cannot be supplied by domestic competition in the importing countries.  But most appreciate there is little point trying to sell additional volume, as this would merely lead to a price war and lower margins.  They also know, unlike investors, that exporting additional volumes – if major new capacity is built – will be very hard indeed.

The chart shows latest portfolio price movements since January 2013 with ICIS pricing comments below:

PTA China, red, down 17%. “Downbeat market outlook for the downstream polyethylene terephthalate (PET) and polyester fibre demand”
Benzene Europe, green, down 14%. “Players are generally in the midst of running down inventories ahead of year-end rather than building stock.”
Brent crude oil, blue, down 1%
Naphtha Europe, black, up 3%.  “European arbitrage window to Asia is well and truly shut, but domestic petrochemical demand will continue to prop up prices as crackers minimise the use of the more expensive alternative feedstock propane”
HDPE USA export, yellow, up 13%. “Limited trade in the week shortened by the US Thanksgiving holiday.
US$: yen, orange, up 16%
S&P 500 stock market index, purple, up 23%

Investors decide central banks may not know what they are doing

D'turn 28Sept13

The blog was speaking last week at the major Euromoney investor conference on bond markets.  It followed a keynote by the head of the UK’s Debt Management Office, who noted that the Bank of England now ‘owned’ ~30% of total UK government debt compared to none in 2008

The reaction to his speech revealed just how investor attitudes to the central banks have changed.  All through the day, it was clear that neither the US Federal Reserve, European Central Bank or Bank of England now command total confidence.  Some very large investors privately expressed the view that central banks no longer knew what they were doing.  And they shared the blog’s concern that the outlook could become quite scary as a result.

Also changing is the attitude to the 4 ‘butterflies’ that the blog discussed in its New Statesman analysis last month.  Its argument was that these could cause a cold winter, just as butterflies flapping their wings in the Amazon can cause snow elsewhere:

  • Interest rates  Nobody now knows what central banks want.  Are rates at their desired level, too high or too low?  Equally, does it matter what they want?  Have they any power to change things?
  • Eurozone.  Nobody also knows what will happen now the German election is over.  Will there be a ‘grand coalition’?  And if so, on what terms might the SPD join Chancellor Merkel’s government?  In addition, what will happen to Italy’s government?  Nobody knows if it will survive the resignation of Berlusconi’s ministers
  • What about the US budget/debt ceiling talks?  The consensus has ignored this issue until very recently.  But on Saturday, the New York Times described it as  “a double-barrelled fiscal crisis”
  • Then there is China’s economic plenum in November.  One major initiative opened yesterday – the new Shanghai free trade zone (FTZ).  “Like father, like son” is clearly the message: President Xi’s father set up the first-ever FTZ in Shenzhen in 1979, which began reopening China to the world after the Mao period.  Now he has done the same, but on a bigger scale

Markets hate uncertainty, but the major investors with whom the blog spoke were not feeling depressed.  Instead, they were starting for the first time in years to do their own thinking, and not just relying on central bank ‘guidance’.  Encouragingly, they were very interested in the arguments of ‘Boom, Gloom and the New Normal’ – another sign that its argument on the importance of changing demographics is becoming mainstream.

But who knows how all this will end?  Who even knows what will happen to oil prices?  Will the promised US-Iran talks be the trigger for prices to fall back to $50/bbl, or lower?  They could be, if markets turn away from today’s absurd consensus that insists on seeing shortages round every corner.  If investors really do start opening their eyes, and thinking independently, there could be quite a lot of changes ahead.

Meantime however, as the chart shows, the divergence between the real world of chemical demand and the liquidity-driven financial markets is very clear.  All the benchmark products are lower in price, highlighting how the only real ‘recovery’ has been in financial assets.

Benchmark price movements since the IeC Downturn Monitor began on 29 April 2011, with ICIS pricing comments this week are below:

PTA China, red, down 21%. “Slower-than-expected downstream polyester demand weighed down buying sentiment and spot prices”
Naphtha Europe, black, down 18%. “Market is oversupplied, suffering from slow domestic demand and sluggish exports to the US gasoline sector”
Brent crude oil, blue, down 13%.
HDPE USA export, yellow, down 10%. “Following the 2 force majeures, inventory tightness has made it difficult to find product for export”
Benzene Europe, green line, down 4%. ”Prices are at a seven-week low, largely as a result of falling crude, lower demand and a dip in US and Asian spot values”
US$: yen, orange, up 21%
S&P 500 stock market index, purple, up 24%