Follow the Vampire Squid to Aluminium

Today’s Money Weekend will touch on a familiar theme before revealing a metal play that could remake one of the world’s biggest industries.

But first, there was no avoiding China this week. Jim Chanos will be smiling. If you happened to catch last week’s MW, you’ll know Jim Chanos is ‘short’ US blue chip Caterpillar, a company highly leveraged to mining and construction, especially in China.

Well, Chanos is on track for the moment. Caterpillar reported this week a 43.5% drop in quarterly profit and cut its outlook for the year, according to Reuters. 

The news this week out of China of a contracting Purchasing Manager’s index won’t have eased any worries in the Caterpillar boardroom, either. Preliminary data has the PMI at 47.7, an 11-month low. A reading above 50 means expansion. Of course, you wonder how reliable and useful any of these readings are. But there’s no doubt they shift sentiment, and in the short term, that moves markets. 

The Two Choices: Inflate or Shakeout?

The question that hangs, of course, is how the Chinese authorities will respond to the continuing slowdown. In the past, any slowdown has been veered off from a familiar playbook: more credit and ‘stimulus’.

It probably boils down to the usual two choices from Washington to Canberra to Beijing. If China stays tight, credit and liquidity could dry up and a lot of industry will get the shakes. That means unemployment and protests, which threatens political stability. The second is to turn the credit tap on again, keeping the growth engine happening to keep millions employed rather than rioting in the streets.

The IMF showed last week that China’s total credit has grown from $9 trillion to $23 trillion since 2008. That’s now 200% of GDP.

Source: IMF

In other words, as yet there doesn’t seem to be any sign of the famous ‘rebalancing’ that’s supposed to be occurring away from investment toward consumption. Chinese Premier Li has made it known previously he isn’t a fan of another major credit expansion. But what about this little snippet in the Australian Financial Review on Friday?

‘Chinese Premier Li Keqiang said the nation will speed railway construction, especially in central and western regions, adding support for an economy that’s set to expand at the slowest pace in 23 years…

‘Additional spending would help the world’s second-largest economy, after the government signalled this week it will protect its 7.5 per cent growth target for this year following a second straight quarterly slowdown.’

You know what they say about old habits…

Is there a limit to this? Greg Canavan over at Sound Money Sound Investments says yes, and that China’s economy is more unbalanced than ever. This is the endgame he’s been hunting, and the reason he expects a panic. But it’s mostly government and politics, not markets, that put the figures you see there that high, so can those same things send them higher again? We don’t think you can rule it out. 

The Vampire Squid Strikes

Of course, you can’t rule out anything these days. The New York Times revealed this week that Goldman Sachs might be manipulating the base metal market in quite a bizarre way. This is, of course, the investment bank that has the reputation that brought out Matt Taibbi’s memorable line to describe them as a ‘great vampire squid wrapped around the face of humanity, relentlessly jamming its blood funnel into anything that smells like money.

The apparent scheme is to keep aluminium traded on the major US commodity exchange in storage for longer via bogus bottlenecks to clip more rent while it sits there. That’s a cost that shows up for the end user, like any time a bloke in the US cracks open a tinny. It’s not strictly illegal, more like a lucrative loophole. And when has a bank ever passed up an opportunity like that?

Check it out!

‘The story of how this works begins in 27 industrial warehouses in the Detroit area where a Goldman subsidiary stores customers’ aluminum. Each day, a fleet of trucks shuffles 1,500-pound bars of the metal among the warehouses. Two or three times a day, sometimes more, the drivers make the same circuits. They load in one warehouse. They unload in another. And then they do it again.’

But the main reason this caught our eye is the metal itself. Aluminium is not a headline metal like gold or silver, but in the latest edition of Australian Small Cap Investigator, Kris Sayce showed how the aluminium market is locked in a high stakes battle with steelmakers for market share in one of the world’s biggest industries: car manufacturing. Any false cost embedded in the metal will be showing up there too.

We’re reliably informed that Goldman’s game is up because ownership of the London Metal Exchange (that regulates the warehousing) has changed hands. The new chiefs in Hong Kong want to put a stop to it. This could bring more supply of aluminium out and bring the price down.

If so, the takeaway for investors is aluminium could became even more attractive to manufacturers. Kris Sayce says it already is something like a ‘magic metal’ because it can reduce car weights and increase fuel efficiency. Had you heard that? No, neither had we. It’s a technological innovation that could be good for your pocket and the environment if the car industry makes a major switch in how they produce their cars.

Kris says the mainstream missed the story completely. Intrigued? You can see what he says here.

Callum Newman+
Editor, Money Weekend

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Callum is a feature editor for Money Morning. He covers areas of interest arising from world markets and the global economy that could mean new investment opportunities for Aussie investors.

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