Objective Capital's Rare Earths, Speciality & Strategic Metals
Investment Summit 2012
Ironmongers' Hall, City of London
13-14 March 2012
Speaker: Chris Watling, Longview Economics
BPPG response - Options for Defined Benefit schemes - 19Apr24.pdf
The macro-economic implications of the strategic metal supply
1. RARE EARTHS, SPECIALITY
& STRATEGIC METALS
INVESTMENT SUMMIT
The macro-economic implications of
the strategic metal supply
Chris Watling – CEO, Longview Economics
IRONMONGERS’ HALL, CITY OF LONDON ● TUESDAY-WEDNESDAY, 13-14 MARCH 2012
www.ObjectiveCapitalConferences.com
2. The Macro Picture
Presentation to Objective Capital conference
Chris Watling, CEO, Longview Economics
13th March 2012
Twitter: Chris@Longview
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Website: www.longvieweconomics.com
3. Contents
3. Kondratieff Long Cycles
4. Western Deleveraging – judging the unwind
5. Asia & Commodities
6. China & Rare Earths
7. Conclusion
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7. Western Secular Bear Market - Ongoing
S&P500 & Dow Jones Industrial Average (both in
real terms) 1910 - present
1600
Long term
secular BULL Evidence for 20 – 25
800 & BEAR year long ‘super’
cycles
cycles exists in the
rebased to 100 (1940)
bull
400
history of equity
bear
bull bear markets in the
200
bull
Western economies
bear
100
50
25
1920 1935 1950 1965 1980 1995 2010
S&P500 (real terms) DJIA (Real terms)
Source: Reuters EcoWin
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8. Long term ‘Super Cycles’: COMMODITIES
The commodity super cycle (1910 – 2011, CRB index)
640
320
1980 bear Commodity
CRB commodity index (logarithmic)
bull
super cycles are
1951 1999-
‘negatively’
160 bear
bull 2001
correlated with
1920
Western Equity
80 1968-
71 super cycles…
bull
40
bear
1932
20
1920 1930 1940 1950 1960 1970 1980 1990 2000 2010
World, CRB, Spot Index, End of Period, USD
CRB index long term Monthly
Source: CRB, Longview Economics, Reuters EcoWin
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9. Secular De-rating Western Equities
(based on Shiller PE ratio)
Table 1: Long term Secular trends – Equities & Commodities (& equity re-rating/de-rating periods)
Equity When? Commodity When? Equity valuation When? PE highs/lows Leveraging/
Trend Trend rerating/derating? Deleveraging*
Bear 1896 - 1920 Bull 1896 - 1920 derating 1901 - 1920 25.2x to 4.8x N/A
Bull 1920 - 1929 Bear 1920 – 1932 rerating 1920 - 1929 4.8x to 32.6 148% to 185%
Bear 1929 - 1932 or Bull 1932 - 1951 derating 1929 - 1932 or 32.6x to 9.0x 185% to 167%**
alternatively to alternatively to
1949 1949
Bull 1949 - 1968 Bear 1951 - 1968 rerating 1949 - 1965 9.0x to 23.9x **149% to 148%
Bear 1968 - 1982 Bull 1968 - 1980 derating 1965 - 1982 23.9x to 6.6x 148% to 174%
Bull 1982 - 2000 Bear 1980 - rerating 1982 - 2000 6.6x to 44.2x 174% to 267%
1999/2001
Bear 2000 - present Bull 1999/2001 to derating 2000 – present 44.2x to 21.9x 267% to 355%
present (current)
Source: Longview Economics, Shiller, CRB commodities index – for further detailed analysis of the commodity super cycle see Longview
Letter no 26 June 2008: “Commodity Super Cycle: Myth or Reality?”
*Leveraging measured as total economy wide debt (excl financial debt) % of nominal GDP
**NB different data sets pre 1949 & post 1949
10. Long term valuations suggest:
Secular Bear continues
Long term valuation ratios (US equities) – Shiller PE ratio
Secular bull
45
markets start with 2000 peak
widespread 40
1929
negative 35 Peak
PE ratio (cyclically adjusted)
sentiment 30
1901
towards equities, peak 1937
1965
25 peak
structurally low peak
equity ownership 20
levels and Shiller 15
PERs of sub 10 10
currently @
21x - above
ratios (e.g. 1920 6.6
long term
average
5
& 1982) 5x
1920
6x
1932
1982
x levels
0
1890 1905 1920 1935 1950 1965 1980 1995 2010
S&P500 PE ratio calculated by the Shiller method (i.e. based on 10 year rolling historical earnings)
Long term average
Source: Shiller, Reuters EcoWin
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11. Contrasting Return Profiles:
BEAR & BULL SUPER CYCLES
Investment approach shld be contrasted in each period
In secular bears = important to trade on 3 – 6 month+ view
Period Bull/ Returns Returns (real Real DJIA index Approx Average real
Bear (nominal terms) numbers (start to compound GDP growth
terms) finish) annual rates
1920 -29 BULL +429% +495% 35.5 to 210.3 +21.9% N/A
1929 – BEAR -56% -68% 210.3 to 67.2 -5.5% 3.9% p.a.
1949/51
1949/51 – BULL +487% +426% 67.2 to 295.8 +9.1% 4.2% p.a.
1966
1966 – 1982 BEAR -17.8% -73.1% 295.8 to 79.4 -7.9% 3.2% p.a.
1982 – 2000 BULL 1,322% +724.2% 79.4 to 654.4 +12.4% 3.7% p.a.
2000 - BEAR FLAT -18.4% (so far) 654.4 to present n/k 1.6% p.a.
current (currently 533.8)
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12. Real Yields – negative (bubble valuation)
US 5 year, real, break-even & UK 10 year & 2016, real, break-
nominal yields even yields
3.0
2.0
2.5
1.5
2.0
1.0
1.5
0.5
1.0
0.0
0.5
-0.5
0.0
-0.5
-1.0
Implied
deflation -1.0 -1.5
-1.5 -2.0
Feb May Aug Nov Feb May Aug Nov Feb May Aug Nov Feb Feb May Aug Nov Feb May Aug Nov Feb May Aug Nov Feb
09 10 11 12
Constant Maturity Inflation-indexed, Breakeven Inflation Bid, Yield 2009 2010 2011 2012
Constant Maturity Inflation-indexed, Yield 0
UK 10 year index linked real yield series UK 2016 index linked real yields 0
Source: Reuters EcoWin Source: Reuters EcoWin
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13. McKinsey Country Debt totals
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14. 2. Western Secular Bear Market –
Ongoing until:
Overarching theme: Bubbles need to be fully deflated –
Excess removed/cleaned out of System – i.e. System
needs to be reset, including:
• Full deflation of Western Housing Bubbles (growth headwind)
• Government finances – back on (path) to sound footing (growth
headwind)
• Households deleveraged (back to pre-bubble levels) – (growth
headwind)
• Financial sector – Fixed/deleveraged/profit as % of GDP downsized –
(growth headwind)
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16. 2a. House Bubble Deflation
Adjustment Trend to Fall from peak Fall from peak Peak Source Inventory
rel to trend lows (i.e. (real terms, %) (nominal adjustment
(% overshoot terms)
complete) downside)
US - FHFA 91% 17.5% 24 16% 2006q4 FHFA 7 months supply
(further from (normal range 4 –
trend) 6 mos) – peak 12.4
US – Case 83.5% 17.5% (from 39 32% Jun 2006 Case As above
Shiller trend) Shiller
UK - 72.9% 44.4% (from 26 20 2007 Q3 Halifax/ N/A (shortage of
Halifax trend) HBOS rental property)
UK – 45.1% 49.1% (from 18 10 2007 Q3 Nationwide N/A (as above)
Nationwide trend)
Spain 72.7% 58.2% (from 23 18 2007 Q3 Ministry of
trend) Housing
Ireland n/a n/a 46 45 Feb 2007 TSB/CSO
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17. Structural western economic growth headwinds:
2a. US Housing bubble – continues to deflate
US House price index (real terms, FHFA) US House price index (real terms, Case-Shiller)
170 Peak
200
peak of
'06 199.1 in
190
Rebased to 100 I Jan 1987 (10 C ities composite)
24.3% '06
160
fall (real
180
terms)
150 170
US real house price index
+58% 160
140 rise
150
Currently
130 140 120.5
Current
130 real terms
120 Peak Peak Aug '89 fall from
'79 peak
'89 120 peak =
+16% +16% 8% Trend? 39.5% latest
14% Total fall 35% 120.5
110 rise fall rise fall 110 peak to
trough in real
100 terms
Trough
100
'95
Trough Trough 90
Feb 97
'75 '82
90 80 trough
1975 1980 1985 1990 1995 2000 2005 2010 86 88 90 92 94 96 98 00 02 04 06 08 10 12
US real house price index (rebased to 100 @ 1 Jan 1975) S&P composite 10 cities Case Shiller index in real terms (rebased to 100 in 1987)
Source: Reuters EcoWin Source: Case Shiller/S&P, Reuters EcoWin
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18. 1. UK House prices – Bubble deflation
UK Real house prices London (real) house prices)
300
Real house price indices (Rebased to 100 @ 1 Jan 1983)
2007 350
London house prices index (real & rebased to 100 1984)
peak
275
167% trough 300
250
to peak boom
- 1996 thro to
225 2007 250
200
Peak 200
175 '89
76%
150 trough to 38% bust
+26% peak 80s 150
boom in boom
Peak
125 70s
'79
100
100 15% Trough
fall Trough '96
Trough '82
75 '77
50
1975 1980 1985 1990 1995 2000 2005 2010 2015 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10 12
Real House prices index (using Halifax & GDP deflator, rebased to 100 1 Jan 1983) London house prices (N'wide) - inflation adjusted
Real House prices index (using Nationwide & GDP deflator, rebased to 100 1 Jan 1974) London house prices (Halifax) - inflation adjusted
Source: Reuters EcoWin, HBOS, Nationwide, Longview Economics Source: Reuters EcoWin
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19. UK House price adjustment
UK house prices to average earnings (xs)
6.0
Years for UK house price/earnings ratio to
return to 3xs (under various assumptions
5.5
for annual house price falls and wage
inflation)
House prices to average earnings
5.0
Annual house price falls
4.5 ZERO -3% -5%
Wage 1.00% 35.0 9.9 5.3
inflation
4.0 2.50% 14.3 7.1 4.6
(Y-o-Y
%) 4.00% 8.9 5.1 3.8
3.5
Source: Longview Economics, Reuters EcoWin
Back to 3xs
earnings?
3.0
1985 1990 1995 2000 2005 2010 2015 2020
mean
Source: Longview Economics, Reuters EcoWin
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20. 2a. Irish House price bubble…still
deflating
Irish house prices – still declining in
….and nominal terms
real terms
110
140 325
Peak @
100 130
100 300
120 275
90
Average price (E UR) (thousands)
A ll rebased to 100 @ Jan 2007
110
250
80
100
225
70 90
Index
200
60 80
175
70
50
150
60
40 125
50
30 40 100
30 75
20
96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11
1996 1998 2000 2002 2004 2006 2008 2010 2012
National house price average (EUR) - series Discontinued
Dublin (inflation adjusted - discontinued series) Real national hse prices Permanent tsb, national, 2003=100, Discontinued
National (inflation adjusted) Dublin rebased (100 Jan 2007) Residential property prices, national, houses, 2005M1=100
Source: Reuters EcoWin Residential property prices, Dublin, all residential properties, 2005M1=100
Source: Reuters EcoWin
23. 2. Deleveraging Studies
The Swedish Comparison
• “Another important driver of the cycle is the leverage of
the private sector. In the decade prior to a crisis,
domestic credit/GDP climbs about 38 percent and
external indebtedness soars. Credit/GDP declines by
an amount comparable to the surge (38 percent)
after the crisis (our emphasis). However, deleveraging
is often delayed and is a lengthy process lasting about
seven years. The decade that preceded the onset of the
2007 crisis fits the historic pattern. If deleveraging of
private debt follows the tracks of previous crises as well,
credit restraint will damp employment and growth for
some time to come.” Reinhart & Reinhart (R&R), August
2010 :‘After The Fall’
- R&R analysis of “fifteen severe post-World War II
financial crises in advanced and emerging economies
and three synchronous global contractions”.
4. “the UK and Spain have made less progress (than the
US) and could be a decade away from reducing their
private sector debt to pre-bubble levels”. McKinsey
Global Institute Jan 2012 Debt & Deleveraging
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24. 2b. Western Household Indebtedness –
deleveraging has begun
US Household debt as % of UK Household debt as % of GDP
GDP
100 105
90 ?? 100
Total US household debt as % of GDP
25 year rising trend ?????
80 95
H'hold debt as % of GDP
70 90
60 with an acceleration 85
since 2000
50 20 year sideways trend 80
40 75
13 year
30 rising 70
trend
20 65
10 60
1950 1960 1970 1980 1990 2000 2010 94 96 98 00 02 04 06 08 10 12 14 16 18 20
US total household debt as % of GDP Source: Reuters EcoWin
Source: Federal Reserve flow of funds, Reuters EcoWin
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25. 2b. UK Household deleveraging
Debt to GDP ratio (%, nominal GDP vs. real GDP since Q4 2009)
Peak in debt/GDP (@105%)
106%
Years of household deleveraging (under
104%
various assumptions for inflation & debt
102% 101%
repayment)* to achieve a 65% debt/GDP ratio
100%
98% Debt repayment (annual %)
96% ZERO 1% 3%
96%
94% 2.00% 11.3 8.5 6.0
92% GDP deflator
3.50% 7.8 6.5 4.8
(Y-o-Y)
90% 5.00% 6.0 5.3 4.0
2006 Q3
2006 Q4
2007 Q1
2007 Q2
2007 Q3
2007 Q4
2008 Q1
2008 Q2
2008 Q3
2008 Q4
2009 Q1
2009 Q2
2009 Q3
2009 Q4
2010 Q1
2010 Q2
2010 Q3
2010 Q4
2011 Q1
2011 Q2
2011 Q3
2011 Q4
Source: Longview Economics
*NB we assume real GDP growth of 1.50% p.a.
Debt to nominal GDP Debt to real GDP
Source: Longview Economics, Reuters EcoWin
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29. 2c. Leveraged US (&UK) financial system
(now deleveraging)
US financial sector debt as a % of GDP
130
122% of GDP
120 peak q109
accelerating rate of
110 financial sector
Financial sector debt as % of GDP
100 indebtedness (in
recent decades) in
90 particular since the
Asian crisis in now 88%
80 1997
1950s - heavily
regulated banking &
70 financial system - banks
stuck to core
60 intermediary business - 1997 @
taking in deposits and
50 lending them onwards 62%
40
30
1952 2.7%
20 of GDP
Beginning of financial
10 deregulation 1970s & early
80s
0
1950 1960 1970 1980 1990 2000 2010
Source: Longview Economics, Federal Reserve flow of funds, Reuters EcoWin
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30. 2c. Rapid growth of Western financial
sector rel to GDP
US commercial bank assets as % Euro zone bank assets as % of
of GDP commercial banks assets as a % of GDP
US GDP
90 350
347% GDP
peak 2010q2
85
325 deleveraging?
80
EZ Banking Assets as % of GDP
Asian crisis - 300
75 start of easy
money &
% of GDP
70 widening of US
current a/c deficit 275
65
250
60
55 225
50
200
1975 1980 1985 1990 1995 2000 2005 2010
97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15
Source: Reuters EcoWin Source: Reuters EcoWin
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32. Demand Drivers:
Developing (& industrialising) Asia: A 3 billion elephant
Largest non developed Asian economies
Asia (Population rank in GDP GDP per capita population Long term Real
size relative to RoW) ($bn 2008) (US$2010) (bn; % of ASIAN total) growth rates
Asia (23) (a) $7,239bn 4,070 3.60 (100.0%)
China (1st) $3,206bn 3,999 1.33 (36.9%) 9.1% (1997-2007)
India (2nd) $1,200bn 1,124 1.13 (31.4%) 9.7% (1997-2007)
Indonesia (4th) $433bn 2,858 0.23 (6.4%) 5.9% (2001-2010)
Pakistan (6th) $143bn 1,067 0.164 (4.6%) 4.8% (2000-2009)
Bangladesh (7th) $68.4bn 624 0.147(4.1%) 7.4 % (1997-2007)
Vietnam (12th) $68.6bn 1,168 0.086 (2.4%) 10.0% (1997-2007)
a: excludes HK, Japan, Singapore, South Korea & Taiwan
NB USA = 3rd 304mn pop; Brazil =5th 191mn; Russia = 8th 142mn; Nigeria = 9th 137mn; Japan = 10th 128mn; Mexico = 11th 110mn
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www.longvieweconomics.com 32
33. Emerging Markets & Say’s Law
(i.e. supply creates its own demand)
Investment rates (i.e. as % of GDP) vs. Real average GDP growth rates (2000-2011)
Real GDP growth (2000-2011)
12
y = 0.2398x - 0.5613
2 China
R = 0.6148 A cross section of 24
10 Asian, Latam & Middle
S Korea in
80s Eastern emerging market
8 economies shows a clear
India relationship between
Vietnam higher investment rates of
6 GDP & higher trend GDP
Russia
growth.
Turkey
4
2 Mexico
0
0 10 20 30 40 50
Inv e stme nt Rate of GDP (2000-2011)
Source: Longview Economics, IMF
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34. Funding higher Investment rates
India – Investment and Savings rate (as % of GDP)
45
Both India’s saving
40 and investment rates
DP
have accelerated
ings rate as %of G
upwards since 2001 –
35 reflecting the
accumulated reform
momentum (beginning
30 with Manmohan
Singh’s reform budget
Investm & sav
of 1991)
ent
25
20
15
80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10 12 14 16
Gross national savings Investment
Source: Reuters EcoWin
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35. China’s Coming Car growth
Japan
900 China Industriali
France
800 Spain
US
sation &
700 Mexico vehicles
Motor vehicles per 1000 people
600 South Korea
500
Italy
Norway
per 1000 per 1,000
The number of vehicles
400 Chile
Germany people India (15), Brazil (198),
people in China is relatively low
(32) - NB
Canada (597) & US (820)
300 Netherlands
UK
200 Canada If China industrialises with the same
Russia vehicle intensity of GDP growth as
100 Brazil other emerging markets the
0 India number of vehicles per 1,000
people in 2030 should still be at
low levels (at 170 vehicles)
- 10,000 20,000 30,000 40,000 50,000
Real GDP per head
Source: Longview Economics, Reuters EcoWin
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36. China’s share of world energy reserves
Energy resources: Share of proven world
reserves (%) – key countries
35.0
28.9
30.0
23.4
25.0
% of world total proven reserves
20.0 19.0
15.0 13.9
10.0
7.1
6.3
5.0 3.6
2.4
1.2 1.3 1.0 0.9 0.6
0.2 0.5
0.0
China Brazil Russia India USA
Oil Gas Coal
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37. China’s Strategic Overseas Investments
(2005 – 2011)
Summary by Sector
Outward Chinese Investment
Sector Total Invested (2005 - 2011) Share of total (%)
US$bn
Agriculture 7.0 2.7%
Energy 114.6 43.6%
Finance 34.3 13.1%
Industry 5.1 2.0%
Metals 69.4 26.4%
Power 8.1 3.1%
Real Estate 11.2 4.2%
Technology 4.5 1.7%
Transport 8.4 3.2%
Total 262.7
Source: Heritage Foundation, China Global Investment Tracker
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38. China - Expanding Trade Relationships
China’s global reach has expanded significantly in the last decade
Share of selected countries'/regions' trade (imports plus exports) with China
last 12 last 12 last 12
2000 2009 months* 2000 2009 months* 2000 2009 months*
G20 Other Significant trading partners Other Significant trading partners
South Korea 9% 20% 23% Mongolia 33% 48% 61% Africa 3% 12% 14%
Australia 7% 20% 21% Kyrgyz Republic 8% 64% 57% Ghana 3% 13% 14%
Japan 10% 20% 21% North Korea 17% 42% 46% Bangladesh 5% 10% 13%
United States 6% 14% 15% Sudan 27% 39% 45% Iraq 5% 8% 13%
Brazil 2% 13% 14% Angola 18% 30% 37% Thailand 5% 12% 12%
South Africa 3% 14% 14% Tajikistan 1% 19% 33% Zimbabwe 2% 7% 11%
Indonesia 5% 12% 13% Myanmar 13% 24% 29% Middle East 4% 10% 11%
Saudi Arabia 3% 12% 13% Congo 5% 20% 25% Singapore 5% 10% 11%
India 2% 9% 11% Kazakhstan 6% 21% 24% Sri Lanka 2% 10% 10%
Argentina 4% 9% 11% Uzbekistan 1% 15% 18% CIS and Mongolia 4% 10% 10%
Russia 5% 9% 9% Nepal 5% 12% 18% Venezuela 0% 7% 8%
Canada 2% 7% 7% Malaysia 3% 13% 17% Syrian Arab Republic 2% 7% 7%
Turkey 2% 6% 7% Iran 5% 15% 17% Nigeria 1% 7% 7%
UK 2% 6% 6% Zambia 1% 8% 17% Somalia 0% 5% 5%
Germany 2% 6% 6% Philippines 2% 8% 15% Spain 2% 4% 4%
Italy 2% 4% 5% Turkmenistan 1% 11% 15% Qatar 3% 3% 4%
EU-25 2% 4% 5% Pakistan 4% 10% 15% Azerbaijan 1% 3% 3%
Mexico 1% 8% 5% APEC 7% 14% 14% Afghanistan 4% 3% 2%
France 2% 3% 4%
* from Dec 2009 to Nov 2010. Calculated as each country's total exports to China + total imports from China / the country's total exports + total imports
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Source: Longview Economics, Reuters Ecowin
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39. China’s Tentacles (EurAsia, Africa & beyond)
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40. China – Geopolitics & rare earths as a political tool
bal trade chokepoints/bottlenecks
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41. China & Rare Earths
1. Rare earth deposits approx 35% of world total
2. China = 90% of global output of 17 rare earth metals
3. Miao Wei (minister for industray and IT) – China to retain
limits on rare earth export quotas (2012 = 2011)
4. Miao: Domestic industry value: $6.4bn
5. Japan – providing ¥5bn in subsidies for R-E projects (Feb
statement MITI)
6. Chinese Industry Rare Earth Association expected soon
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42. Conclusion – Overview (Long term)
• Western Equities – in secular bear market
– Driven by:
b) Ongoing housing bubble deflation
c) Financial system deleveraging
d) Fiscal austerity
• Emerging equities – in secular bull market
– Driven by:
b) Industrialisation
c) Income catch-up/rapid productivituy development
d) Economic Liberalisation/Opening up of/deregulation of economies
e) Financial liberalisation (after decades of financial respression)
f) Commodity wealth
• Commodities – in secular super bull cycle
– but facing some near term cyclical challenges – related primarily to China’s housing market
– Long term supply shortages – with emergence of China & India (amongst others)
• Western equities – rally possible through into Q2 2012 – based on excess pessimism @ lows…
(indicators) – dependent on nr term EURO sol’n/patch (which is now in place)
• Key Long Term issue: Inflation or Deflation
• UK Dire Decade – adjustment approx half way through
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