The interest rate cut yesterday by the Reserve Bank of Australia suggests that finally the RBA understands that the Chinese economy will not keep expanding at a rapid rate while its major trading partners are struggling. But even if the Chinese economy slows more than most economists expect this is unlikely to send the global economy back into a GFC-like slump.
For over a year I have been outlining the reasons why the Chinese economy would slow and highlighting how Australian policy makers should have been taking measures to buffer the economy from such a slowdown.
While many mainstream economic media reporters were saying it was certain that interest rates would rise this year, I suggested the next move should be down. Where others saw strength I saw weakness. Do I have a crystal ball or were the warning signs obvious?
The answer is that the warning signs were obvious. The global economy was always set to hit a weak spot once economic stimulus measures were scaled back or terminated.
It’s not that hard to get a basic grasp on what the global economy is doing by looking at oil prices, the Baltic Dry Index, the stock market and the price of gold.
If oil prices for example are rising then this generally suggests demand is strong and if demand is strong, then this suggests the major economies are doing well. Of course oil prices can surge due to geopolitical issues but we can easily identify these as the cause when it happens and not link the higher prices at those times to a surge in demand.
The Baltic Dry Index (BDI) gives us an idea how much trade is moving globally since the shipping sector carries around 90% of the world trade. If the global economy is ticking along nicely then the shipping rates are around or above the long term average and the shipping companies are doing well.
If the demand for oil is strong and the world shipping fleets are busy then generally speaking the major stock markets are edging upwards and most investors are happy.
The we have gold which tends to lag stock returns when times are good. But when the market is fearful the gold price heads higher as investors sell out of other investment classes in order to get a warm and fuzzy feeling by owning a lump of metal. (while plenty of other cunning investors ride the price up and take profits along the way)
I have looked at these economic and market indicators many times over the last few years and they have generally been able to give me a fairly good idea of how the global economy is tracking.
So now as we draw close to the end of 2011, let’s look at these indicators again and see if we can get a feel for the state of the global economy.
Oil Prices and Oil Demand
Oil Price 5 Year Chart – Brent Crude
The price of oil per barrel never did make it to US $200 in 2007-2008 despite the bullish calls of many commodities traders back then. It did however head for the floor during the GFC but has since recovered pretty well.
Overall the demand for oil appears to be increasing and according to the International Energy Agency (IEA)
“Global oil demand is expected to rise to 89.2 mb/d in 2011 (+0.9 mb/d y-o-y) and reach 90.5 mb/d (+1.3 mb/d) in 2012.”
So it appears at this stage that the demand for oil is holding up pretty well and this suggests to me that the global economy is still expanding. Yes it is pretty tough going in many advanced developed economies, but the world is till open for business.
Next let’s look at one of my favourite economic indicators, the Baltic Dry Index (BDI).
The Baltic Dry Index
Baltic Dry Index 1 year Chart
The BDI is currently just under 2000 which is roughly the long term average for the Index. It however is a long way below the high of 2007 where it was trading briefly up near the 12,000 level! (yes I really mean 12,000 it isn’t a typing error)
The BDI looks weak to me and the major shipping companies are doing it tough right now. Many are still cutting capacity via such means as scrapping ships or slow-steaming, but at the moment many of the big players are still running at a loss.
So my reading of the BDI is that global trade remains weak at this stage and that we won’t see a sustained market rally until the BDI regains its mojo.
The Australian Stock Market
ASX All Ordinaries Index 5 year Chart
As for the stock market, well the ASX All Ordinaries & S&P/ASX 200 are still trading at recession-like levels. Stock market investors haven’t had much to be cheerful about in 2011 and it looks like it will be many months before we see the All Ords/ASX 200 up near 5000 again.
Lastly let’s look at gold prices by using the chart for the ETF ASX:GOLD.
ETF:GOLD 5 Year Price Chart
Certainly gold has done well over the last few years (along with many commodities related stocks) and it is likely to hold up fairly well whilst investors are fearful.
However I believe gold prices are too high and will undergo a sharp correction at some point. Since my market timing skills are poor I have chosen the safe option and am not storing gold bars under my bed.
What the gold price does suggest is that there is still a lot of fear out there and this fear will keep the market volatile. The fairly big stock market swings up and down will be with us for some time to come.
My view is that the global economy is not going to crash and we won’t see another massive crisis as we did in 2008/2009. Many developed economies will struggle while they sort out their debt issues but on the other hand many developing economies will continue to expand.
With some luck, 2012 might be the year where the markets settle down and we get back to focusing on the fundamentals again like P/E ratios and company earnings.
Greg Atkinson is the editor of Shareswatch Australia and the Managing Director of Ohori Capital He is originally from Australia but currently resides in Japan. He can be followed on twitter via @GregAtkinson_jp