The Burning Questions For 2015

John Mauldin
 
Dec 18, 2014


 

Louis Gave is one of my favorite investment and economic thinkers, besides being a good friend and an all-around fun guy. When he and his father Charles and the well-known European journalist Anatole Kaletsky decided to form Gavekal some 15 years ago, Louis moved to Hong Kong, as they felt that Asia and especially China would be a part of the world they would have to understand. Since then Gavekal has expanded its research offices all over the world. The Gavekal team’s various research arms produce an astounding amount of work on an incredibly wide range of topics, but somehow Louis always seems to be on top of all of it.

Longtime readers know that I often republish a piece by someone in their firm (typically Charles or Louis). I have to be somewhat judicious, as their research is actually quite expensive, but they kindly give me permission to share it from time to time.

This week, for your Outside the Box reading, I bring you one of the more thought-provoking pieces I’ve read from Louis in some time. In Thoughts from the Frontline I have been looking at world problems we need to focus on as we enter 2015. Today, Louis also gives us a piece along these lines, called “The Burning Questions for 2015,” in which he thinks about a “Chinese Marshall Plan” (and what a stronger US dollar might do to China), Abenomics as a “sideshow,” US capital misallocation, and whether or not we should even care about Europe. I think you will find the piece well worth your time.

Think about this part of his conclusion as you read:

Most investors go about their job trying to identify ‘winners’. But more often than not, investing is about avoiding losers. Like successful gamblers at the racing track, an investor’s starting point should be to eliminate the assets that do not stand a chance, and then spread the rest of one’s capital amongst the remainder.

Wise words indeed.

A Yellow Card from Barry


What you don’t often get to see is the lively debate that happens among my friends about my writing, even as I comment on theirs. Barry Ritholtz of The Big Picture pulled a yellow card on me over a piece of data he contended I had cherry-picked from Zero Hedge. He has a point. I should have either not copied that sentence (the rest of the quote was OK) or noted the issue date. Quoting Barry:

Did you cherry pick this a little much? 

“… because since December 2007, or roughly the start of the global depression, shale oil states have added 1.36 million jobs while non-shale states have lost 424,000 jobs.”

I must point out how intellectually disingenuous this start date is, heading right into the crisis – why not use December 2010? Or 5 or 10 years? This is misleading in other ways:

It is geared to start before the crisis & recovery, so that it forces the 10 million jobs lost in the crisis to be offset by the 10 million new jobs added since the recovery began. That creates a very misleading picture of where growth comes from.

We have created 10 million new jobs since June 2009. Has Texas really created 4 million new jobs? The answer is no.

According to [the St. Louis Fed] FRED [database]:

PAYEMS – or NFP – has gone from 130,944 to 140,045, a gain of 9,101 over that period.
TXNA – Total Nonfarm in Texas – has gone from 10,284 to 11,708, for a gain of 1,424.

That gain represents 15.6% of the 9.1MM total.

Well yes, Barry, but because of oil and other things (like a business-friendly climate), Texas did not lose as many jobs in the recession as the rest of the nation did, which is where you can get skewed data, depending on when you start the count and what you are trying to illustrate.

My main point is that energy production has been a huge upside producer of jobs, and that source of new jobs is going away. And yes, Josh, the net benefit for at least the first six months until the job non-production shows up (if it does) is a positive for the economy and the consumer. But I was trying to highlight a potential problem that could hurt US growth. Oil is likely to go to $40 before settling in the $50 range for a while. Will it eventually go back up? Yes. But it’s anybody’s guess as to when.

By the way, a former major hedge fund manager who closed his fund a number of years ago casually mentioned at a party the other night that he hopes oil goes to $35 and that we see a true shakeout in the oil patch. He grew up in a West Texas oil family and truly understands the cycles in the industry, especially for the smaller producers. From his point of view, a substantial shakeout creates massive upside opportunities in lots of places. “Almost enough,” he said, “to tempt me to open a new fund.”

It is time to hit the send button. I trust you are having a good week. Now settle in and grab a cup of coffee or some wine (depending on the time of day and your mood), and let’s see what Louis has to say.

Your trying to catch up analyst,

John Mauldin, Editor
Outside the Box



The Burning Questions For 2015

By Louis-Vincent Gave, Gavekal / Dragonomics

 
With two reports a day, and often more, readers sometimes complain that keeping tabs on the thoughts of the various Gavekal analysts can be a challenge. So as the year draws to a close, it may be helpful if we recap the main questions confronting investors and the themes we strongly believe in, region by region.


1. A Chinese Marshall Plan?

When we have conversations with clients about China – which typically we do between two and four times a day – the talk invariably revolves around how much Chinese growth is slowing (a good bit, and quite quickly); how undercapitalized Chinese banks are (a good bit, but fat net interest margins and preferred share issues are solving the problem over time); how much overcapacity there is in real estate (a good bit, but – like youth – this is a problem that time will fix); how much overcapacity there is in steel, shipping, university graduates and corrupt officials; how disruptive China’s adoption of assembly line robots will be etc.

All of these questions are urgent, and the problems that prompted them undeniably real, which means that China’s policymakers certainly have their plates full. But this is where things get interesting: in all our conversations with Western investors, their conclusion seems to be that Beijing will have little choice but to print money aggressively, devalue the renminbi, fiscally stimulate the economy, and basically follow the path trail-blazed (with such success?) by Western policymakers since 2008. However, we would argue that this conclusion represents a failure both to think outside the Western box and to read Beijing’s signal flags.

In numerous reports (and in Chapters 11 to 14 of Too Different For Comfort) we have argued that the internationalization of the renminbi has been one of the most significant macro events of recent years. This internationalization is continuing apace: from next to nothing in 2008, almost a quarter of Chinese trade will settle in renminbi in 2014:

This is an important development which could have a very positive impact on a number of emerging markets. Indeed, a typical, non-oil exporting emerging market policymaker (whether in Turkey, the Philippines, Vietnam, South Korea, Argentina or India) usually has to worry about two things that are completely out of his control:

1)   A spike in the US dollar. Whenever the US currency shoots up, it presents a hurdle for growth in most emerging markets. The first reason is that most trade takes place in US dollars, so a stronger US dollar means companies having to set aside more money for working capital needs. The second is that most emerging market investors tend to think in two currencies: their own and the US dollar. Catch a cab in Bangkok, Cairo, Cape Town or Jakarta and ask for that day’s US dollar exchange rate and chances are that the driver will know it to within a decimal point. This sensitivity to exchange rates is important because it means that when the US dollar rises, local wealth tends to flow out of local currencies as investors sell domestic assets and into US dollar assets, typically treasuries (when the US dollar falls, the reverse is true).

2)   A rapid rise in oil or food prices. Violent spikes in oil and food prices can be highly destabilizing for developing countries, where the median family spends so much more of their income on basic necessities than the typical Western family. Sudden spikes in the price of food or energy can quickly create social and political tensions. And that’s not all; for oil-importing countries, a spike in oil prices can lead to a rapid deterioration in trade balances. These tend to scare foreign investors away, so pushing the local currency lower and domestic interest rates higher, which in turn leads to weaker growth etc...

Looking at these two concerns, it is hard to escape the conclusion that, as things stand, China is helping to mitigate both:

  • China’s policy of renminbi internationalization means that emerging markets are able gradually to reduce their dependence on the US dollar. As they do, spikes in the value of the US currency (such as we have seen in 2014) are becoming less painful.
     
  • The slowdown in Chinese oil demand, as well as China’s ability to capitalize on Putin’s difficulties to transform itself from a price-taker to a price-setter, means that the impact of oil and commodities on trade balances is much more contained.

Beyond providing stability to emerging markets, the gradual acceptance of the renminbi as a secondary trading and reserve currency for emerging markets has further implications. The late French economist Jacques Rueff showed convincingly how, when global trade moved from a gold-based settlement system to a US dollar-based system, purchasing power was duplicated. As the authors of a recent Wall Street Journal article citing Reuff’s work explained: “If the Banque de France counts among its reserves dollar claims (and not just gold and French francs) – for example a Banque de France deposit in a New York bank – this increases the money supply in France but without reducing the money supply of the US. So both countries can use these dollar assets to grant credit.” Replace Banque de France with Bank Indonesia, and US dollar with renminbi and the same causes will lead to the same effects.

Consider British Columbia’s recently issued AAA-rated two year renminbi dim sum bond. Yielding 2.85%, this bond was actively subscribed to by foreign central banks, which ended up receiving more than 50% of the initial allocation (ten times as much as in the first British Columbia dim sum issue two years ago). After the issue British Columbia takes the proceeds and deposits them in a Chinese bank, thereby capturing a nice spread. In turn, the Chinese bank can multiply this money five times over (so goes money creation in China). Meanwhile, the Indonesian, Korean or Kazakh central banks that bought the bonds now have an asset on their balance sheet which they can use to back an expansion of trade with China...

Of course, for trade to flourish, countries need to be able to specialize in their respective comparative advantages, hence the importance of the kind of free trade deals discussed at the recent APEC meeting. But free trade deals are not enough; countries also need trade infrastructure (ports, airports, telecoms, trade finance banks etc...). This brings us to China’s ‘new silk road’ strategy and the recent announcement by Beijing of a US$40bn fund to help finance road and rail infrastructure in the various ‘stans’ on its western borders in a development that promises to cut the travel time from China to Europe from the current 30 days by sea to ten days or less overland.

Needless to say, such a dramatic reduction in transportation time could help prompt some heavy industry to relocate from Europe to Asia.

That’s not all. At July’s BRICS summit in Brazil, leaders of the five member nations signed a treaty launching the US$50bn New Development Bank, which Beijing hopes will be modeled on China Development Bank, and is likely to compete with the World Bank. This will be followed by the establishment of a China-dominated BRICS contingency fund (challenging the International Monetary Fund). Also on the cards is an Asian Infrastructure Investment Bank to rival the Asian Development Bank.

So what looks likely to take shape over the next few years is a network of railroads and motorways linking China’s main production centers to Bangkok, Singapore, Karachi, Almaty, Moscow, Yangon, Kolkata. We will see pipelines, dams, and power plants built in Siberia, Central Asia, Pakistan and Myanmar; as well as airports, hotels, business centers... and all of this financed with China’s excess savings, and leverage. Given that China today has excess production capacity in all of these sectors, one does not need a fistful of university diplomas to figure out whose companies will get the pick of the construction contracts.

But to finance all of this, and to transform herself into a capital exporter, China needs stable capital markets and a strong, convertible currency. This explains why, despite Hong Kong’s pro-democracy demonstrations, Beijing is pressing ahead with the internationalization of the renminbi using the former British colony as its proving ground (witness the Shanghai-HK stock connect scheme and the removal of renminbi restrictions on Hong Kong residents). And it is why renminbi bonds have delivered better risk-adjusted returns over the past five years than almost any other fixed income market.

Of course, China’s strategy of internationalizing the renminbi, and integrating its neighbors into its own economy might fall flat on its face. Some neighbors bitterly resent China’s increasing assertiveness. Nonetheless, the big story in China today is not ‘ghost cities’ (how long has that one been around?) or undercapitalized banks. The major story is China’s reluctance to continue funneling its excess savings into US treasuries yielding less than 2%, and its willingness to use that capital instead to integrate its neighbors’ economies with its own; using its own currency and its low funding costs as an ‘appeal product’ (and having its own companies pick up the contracts as a bonus). In essence, is this so different from what the US did in Europe in the 1940s and 1950s with the Marshall Plan?

2. Japan: Is Abenomics just a sideshow?

With Japan in the middle of a triple dip recession, and Japanese households suffering a significant contraction in real disposable income, it might seem that Prime Minister Shinzo Abe has chosen an odd time to call a snap election. Three big factors explain his decision:

1)   The Japanese opposition is in complete disarray. So Abe’s decision may primarily have been opportunistic.

2)   We must remember that Abe is the most nationalist prime minister Japan has produced in a generation. The expansion of China’s economic presence across Central and South East Asia will have left him feeling at least as uncomfortable as anyone who witnessed his Apec handshake with Xi Jinping three weeks ago. It is not hard to imagine that Abe returned from Beijing convinced that he needs to step up Japan’s military development; a policy that requires him to command a greater parliamentary majority than he holds now.

3)   The final factor explaining Abe’s decision to call an election may be that in Japan the government’s performance in opinion polls seems to mirror the performance of the local stock market (wouldn’t Barack Obama like to see such a correlation in the US?). With the Nikkei breaking out to new highs, Abe may feel that now is the best time to try and cement his party’s dominant position in the Diet.

As he gets ready to face the voters, how should Abe attempt to portray himself? In our view, he could do worse than present himself as Japan Inc’s biggest salesman.
 
Since the start of his second mandate, Abe has visited 49 countries in 21 months, and taken hundreds of different Japanese CEOs along with him for the ride. The message these CEOs have been spreading is simple: Japan is a very different place from 20 years ago. Companies are doing different things, and investment patterns have changed. Many companies have morphed into completely different animals, and are delivering handsome returns as a result. The relative year to date outperformances of Toyo Tire (+117%), Minebea (+95%), Mabuchi (+57%), Renesas (+43%), Fuji Film (+33%), NGK Insulators (+33%) and Nachi-Fujikoshi (+19%) have been enormous. Or take Panasonic as an example: the old television maker has transformed itself into a car parts firm, piggy-backing on the growth of Tesla’s model S.

Yet even as these changes have occurred, most foreign investors have stopped visiting Japan, and most sell-side firms have stopped funding genuine and original research. For the alert investor this is good news. As the number of Japanese firms at the heart of the disruptions reshaping our global economy – robotics, electric and self-driving cars, alternative energy, healthcare, care for the elderly – continues to expand, and as the number of investors looking at these same firms continues to shrink, those investors willing to sift the gravel of corporate Japan should be able to find real gems.

Which brings us to the real question confronting investors today: the ‘Kuroda put’ has placed Japanese equities back on investor’s maps. But is this just a short term phenomenon? After all, no nation has ever prospered by devaluing its currency. If Japan is set to attract, and retain, foreign investor flows, it will have to come up with a more compelling story than ‘we print money faster than anyone else’.

In our recent research, we have argued that this is exactly what is happening. In fact, we believe so much in the opportunity that we have launched a dedicated Japan corporate research service (GK Plus Alpha) whose principals (Alicia Walker and Neil Newman) are burning shoe leather to identify the disruptive companies that will trigger Japan’s next wave of growth.

3. Should we worry about capital misallocation in the US?

The US has now ‘enjoyed’ a free cost of money for some six years. The logic behind the zero-interest rate policy was simple enough: after the trauma of 2008, the animal spirits of entrepreneurs needed to be prodded back to life. Unfortunately, the last few years have reminded everyone that the average entrepreneur or investor typically borrows for one of two reasons:

  • Capital spending: Business is expanding, so our entrepreneur borrows to open a new plant, or hire more people, etc.
     
  • Financial engineering: The entrepreneur or investor borrows in order to purchase an existing cash flow, or stream of income. In this case, our borrower calculates the present value of a given income stream, and if this present value is higher than the cost of the debt required to own it, then the transaction makes sense.

Unfortunately, the second type of borrowing does not lead to an increase in the stock of capital. It simply leads to a change in the ownership of capital at higher and higher prices, with the ownership of an asset often moving away from entrepreneurs and towards financial middlemen or institutions. So instead of an increase in an economy’s capital stock (as we would get with increased borrowing for capital spending), with financial engineering all we see is a net increase in the total amount of debt and a greater concentration of asset ownership. And the higher the debt levels and ownership concentration, the greater the system’s fragility and its inability to weather shocks.

We are not arguing that financial engineering has reached its natural limits in the US. Who knows where those limits stand in a zero interest rate world? However, we would highlight that the recent new highs in US equities have not been accompanied by new lows in corporate spreads. Instead, the spread between 5-year BBB bonds and 5-year US treasuries has widened by more than 30 basis points since this summer.

Behind these wider spreads lies a simple reality: corporate bonds issued by energy sector companies have lately been taken to the woodshed. In fact, the spread between the bonds of energy companies, and those of other US corporates are back at highs not seen since the recession of 2001-2002, when the oil price was at US$30 a barrel.

The market’s behavior raises the question whether the energy industry has been the black hole of capital misallocation in the era of quantitative easing. As our friend Josh Ayers of Paradarch Advisors (Josh publishes a weekly entitled The Right Tale, which is a fount of interesting ideas. He can be reached at josh@paradarchadvisors.com) put it in a recent note: “After surviving the resource nadir of the late 1980s and 1990s, oil and gas firms started pumping up capex as the new millennium began. However, it wasn’t until the purported end of the global financial crisis in 2009 that capital expenditure in the oil patch went into hyperdrive, at which point capex from the S&P 500’s oil and gas subcomponents jumped from roughly 7% of total US fixed investment to over 10% today.”

“It’s no secret that a decade’s worth of higher global oil prices justified much of the early ramp-up in capex, but a more thoughtful look at the underlying data suggests we’re now deep in the malinvestment phase of the oil and gas business cycle. The second chart (above) displays both the total annual capex and the return on that capex (net income/capex) for the ten largest holdings in the Energy Select Sector SPDR (XLE). The most troublesome aspect of this chart is that, since 2010, returns have been declining as capex outlays are increasing. Furthermore, this divergence is occurring despite WTI crude prices averaging nearly $96 per barrel during that period,” Josh noted.

The energy sector may not be the only place where capital has been misallocated on a grand scale. The other industry with a fairly large target on its back is the financial sector. For a start, policymakers around the world have basically decided that, for all intents and purposes, whenever a ‘decision maker’ in the financial industry makes a decision, someone else should be looking over the decision maker’s shoulder to ensure that the decision is appropriate. Take HSBC’s latest results: HSBC added 1400 compliance staff in one quarter, and plans to add another 1000 over the next quarter. From this, we can draw one of two conclusions:

1)   The financial firms that will win are the large firms, as they can afford the compliance costs.

2)   The winners will be the firms that say: “Fine, let’s get rid of the decision maker. Then we won’t need to hire the compliance guy either”.

This brings us to a theme first explored by our friend Paul Jeffery, who back in September wrote: “In 1994 Bill Gates observed: ‘Banking is necessary, banks are not’. The primary function of a bank is to bring savers and users of capital together in order to facilitate an exchange. In return for their role as [trusted] intermediaries banks charge a generous net spread. To date, this hefty added cost has been accepted by the public due to the lack of a credible alternative, as well as the general oligopolistic structure of the banking industry. What Lending Club and other P2P lenders do is provide an online market-place that connects borrowers and lenders directly; think the eBay of loans and you have the right conceptual grasp. Moreover, the business model of online market-place lending breaks with a banking tradition, dating back to 14th century Florence, of operating on a “fractional reserve” basis. In the case of P2P intermediation, l ending can be thought of as being “fully reserved” and entails no balance sheet risk on the part of the service facilitator. Instead, the intermediary receives a fee- based revenue stream rather than a spread-based income.”

There is another way we can look at it: finance today is an abnormal industry in two important ways:

1)   The more the sector spends on information and communications technology, the bigger a proportion of the economic pie the industry captures. This is a complete anomaly. In all other industries (retail, energy, telecoms...), spending on ICT has delivered savings for the consumers. In finance, investment in ICT (think shaving seconds of trading times in order to front run customer orders legally) has not delivered savings for consumers, nor even bigger dividends for shareholders, but fatter bonuses and profits for bankers.

2)   The second way finance is an abnormal industry (perhaps unsurprisingly given the first factor) lies in the banks’ inability to pass on anything of value to their customers, at least as far as customer’s perceptions are concerned. Indeed, in ‘brand surveys’ and ‘consumer satisfaction reports’, banks regularly bring up the rear. Who today loves their bank in a way that some people ‘love’ Walmart, Costco, IKEA, Amazon, Apple, Google, Uber, etc?

Most importantly, and as Paul highlights above, if the whole point of the internet is to:

a) measure more efficiently what each individual needs, and

b) eliminate unnecessary intermediaries,

then we should expect a lot of the financial industry’s safe and steady margins to come under heavy pressure. This has already started in the broking and in the money management industries (where mediocre money managers and other closet indexers are being replaced by ETFs). But why shouldn’t we start to see banks’ high return consumer loan, SME loan and credit card loan businesses replaced, at a faster and faster pace, by peer-to-peer lending? Why should consumers continue to pay high fees for bank transfers, or credit cards when increasingly such services are offered at much lower costs by firms such as TransferWise, services like Alipay and Apple Pay, or simply by new currencies such as Bitcoin? On this point, we should note that in the 17 days that followed the launch of Apple Pay on the iPhone 6, almost 1% of Wholefoods’ transactions were processed using the new payment system. The likes of Apple, Google, Facebook and Amazon have grown int o behemoths by upending the media, advertising retail and entertainment industries. Such a rapid take- up rate for Apple Pay is a powerful indicator which sector is likely to be next in line. How else can these tech giants keep growing and avoid the fate that befell Sony, Microsoft and Nokia? On their past record, the technology companies will find margins, and growth, in upending our countries’ financial infrastructure. As they do, a lot of capital (both human and monetary) deployed in the current infrastructure will find itself obsolete.

This possibility raises a number of questions – not least for Gavekal’s own investment process, which relies heavily on changes in the velocity of money and in the willingness and ability of commercial banks to multiply money, to judge whether it makes sense to increase portfolio risk. What happens to a world that moves ‘ex-bank’ and where most new loans are extended peer-to-peer? In such a world, the banking multiplier disappears along with fractional reserve banking (and consequently the need for regulators? Dare to dream...). As bankers stop lending their clients umbrellas when it is sunny, and taking them away when it rains, will our economic cycles become much tamer? As central banks everywhere print money aggressively, could the market be in the process of creating currencies no longer based on the borders of nation states, but instead on the cross-border networks of large corporations (Alipay, Apple Pay...), or even on voluntary communi ties (Bitcoin). Does this mean we are approaching the Austrian dream of a world with many, non government-supported, currencies?

4. Should we care about Europe?

In our September Quarterly Strategy Chartbook, we debated whether the eurozone was set for a revival (the point expounded by François) or a continued period stuck in the doldrums (Charles’s view), or whether we should even care (my point). At the crux of this divergence in views is the question whether euroland is broadly following the Japanese deflationary bust path. Pointing to this possibility are the facts that 11 out of 15 eurozone countries are now registering annual year-on-year declines in CPI, that policy responses have so far been late, unclear and haphazard (as they were in Japan), and that the solutions mooted (e.g. European Commission president Jean-Claude Juncker’s €315bn infrastructure spending plan) recall the solutions adopted in Japan (remember all those bridges to nowhere?). And that’s before going into the structural parallels: ageing populations; dysfunctional, undercapitalized and overcrowded banking systems; influe ntial segments of the population eager to maintain the status quo etc...

With the same causes at work, should we expect the same consequences? Does the continued underperformance of eurozone stocks simply reflect that managing companies in a deflationary environment is a very challenging task? If euroland has really entered a Japanese-style deflationary bust likely to extend years into the future, the conclusion almost draws itself.

The main lesson investors have learned from the Japanese experience of 1990-2013 is that the only time to buy stocks in an economy undergoing a deflationary bust is:

a)   when stocks are massively undervalued relative both to their peers and to their own history, and

b)   when a significant policy change is on the way.

This was the situation in Japan in 1999 (the first round of QE under PM Keizo Obuchi), 2005 (PM Junichiro Koizumi’s bank recapitalization program) and of course in 2013-14 (Abenomics). Otherwise, in a deflationary environment with no or low growth, there is no real reason to pile into equities. One does much better in debt. So, if the Japan-Europe parallel runs true, it only makes sense to look at eurozone equities when they are both massively undervalued relative to their own histories and there are expectations of a big policy change. This was the case in the spring of 2012 when valuations were at extremes, and Mario Draghi replaced Jean-Claude Trichet as ECB president. In the absence of these two conditions, the marginal dollar looking for equity risk will head for sunnier climes.

With this in mind, there are two possible arguments for an exposure to eurozone equities:

1)   The analogy of Japan is misleading as euroland will not experience a deflationary bust (or will soon emerge from deflation).

2)   We are reaching the point when our two conditions – attractive valuations, combined with policy shock and awe – are about to be met. Thus we could be reaching the point when euroland equities start to deliver outsized returns.

Proponents of the first argument will want to overweight euroland equities now, as this scenario should lead to a rebound in both the euro and European equities (so anyone underweight in their portfolios would struggle). However, it has to be said that the odds against this first outcome appear to get longer with almost every data release!

Proponents of the second scenario, however, can afford to sit back and wait, because it is likely any outperformance in eurozone equities would be accompanied by euro currency weakness. Hence, as a percentage of a total benchmark, European equities would not surge, because the rise in equities would be offset by the falling euro.

Alternatively, investors who are skeptical about either of these two propositions can – like us – continue to use euroland as a source of, rather than as a destination for, capital. And they can afford safely to ignore events unfolding in euroland as they seek rewarding investment opportunities in the US or Asia. In short, over the coming years investors may adopt the same view towards the eurozone that they took towards Japan for the last decade: ‘Neither loved, nor hated... simply ignored’.

Conclusion:

Most investors go about their job trying to identify ‘winners’. But more often than not, investing is about avoiding losers. Like successful gamblers at the racing track, an investor’s starting point should be to eliminate the assets that do not stand a chance, and then spread the rest of one’s capital amongst the remainder.

For example, if in 1981 an investor had decided to forego investing in commodities and simply to diversify his holdings across other asset classes, his decision would have been enough to earn himself a decade at the beach. If our investor had then returned to the office in 1990, and again made just one decision – to own nothing in Japan – he could once again have gone back to sipping margaritas for the next ten years. In 2000, the decision had to be not to own overvalued technology stocks. By 2006, our investor needed to start selling his holdings in financials around the world. And by 2008, the money-saving decision would have been to forego investing in euroland.

Of course hindsight is twenty-twenty, and any investor who managed to avoid all these potholes would have done extremely well. Nevertheless, the big question confronting investors today is how to avoid the potholes of tomorrow. To succeed, we believe that investors need to answer the following questions:

  • Will Japan engineer a revival through its lead in exciting new technologies (robotics, hi-tech help for the elderly, electric and driverless cars etc...), or will Abenomics prove to be the last hurrah of a society unable to adjust to the 21st century? Our research is following these questions closely through our new GK Plus Alpha venture.
     
  • Will China slowly sink under the weight of the past decade’s malinvestment and the accompanying rise in debt (the consensus view) or will it successfully establish itself as Asia’s new hegemon? Our Beijing based research team is very much on top of these questions, especially Tom Miller, who by next Christmas should have a book out charting the geopolitical impact of China’s rise.
     
  • Will Indian prime minister Narendra Modi succeed in plucking the low-hanging fruit so visible in India, building new infrastructure, deregulating services, cutting protectionism, etc? If so, will India start to pull its weight in the global economy and financial markets?
     
  • How will the world deal with a US economy that may no longer run current account deficits, and may no longer be keen to finance large armies? Does such a combination not almost guarantee the success of China’s strategy?
     
  • If the US dollar is entering a long term structural bull market, who are the winners and losers? The knee-jerk reaction has been to say ‘emerging markets will be the losers’ (simply because they were in the past. But the reality is that most emerging markets have large US dollar reserves and can withstand a strong US currency. Instead, will the big losers from the US dollar be the commodity producers?
     
  • Have we reached ‘peak demand’ for oil? If so, does this mean that we have years ahead of us in which markets and investors will have to digest the past five years of capital misallocation into commodities?
     
  • Talking of capital misallocation, does the continued trend of share buybacks render our financial system more fragile (through higher gearing) and so more likely to crack in the face of exogenous shocks? If it does, one key problem may be that although we may have made our banks safer through increased regulations (since banks are not allowed to take risks anymore), we may well have made our financial markets more volatile (since banks are no longer allowed to trade their balance sheets to benefit from spikes in volatility). This much appeared obvious from the behavior of US fixed income markets in the days following Bill Gross’s departure from PIMCO. In turn, if banks are not allowed to take risks at volatile times, then central banks will always be called upon to act, which guarantees more capital misallocation, share buybacks and further fragilization of the system (expect more debates along this theme between Charles, and Anatole).
     
  • Will the financial sector be next to undergo disintermediation by the internet (after advertising and the media). If so, what will the macro- consequences be? (Hint: not good for the pound or London property.)
     
  • Is euroland following the Japanese deflationary-bust roadmap?

The answers to these questions will drive performance for years to come. In the meantime, we continue to believe that a portfolio which avoids a) euroland, b) banks, and c) commodities, will do well – perhaps well enough to continue funding Mediterranean beach holidays – especially as these are likely to go on getting cheaper for anyone not earning euros!

Technology firms

Frothy.com

A new tech bubble seems to be inflating. But when it pops, it should cause less damage than the dotcom crash of 2000

Dec 20th 2014
NEW YORK
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IN DECEMBER 15 years ago the dotcom crash was a few weeks away. Veterans of that fiasco may notice some familiar warning signs this festive season. Bankers and lawyers are being priced out of office space in downtown San Francisco; all of the space in eight tower blocks being built has been taken by technology firms. In 2013 around a fifth of graduates from America’s leading MBA schools joined tech firms, almost double the share that struck Faustian pacts with investment banks. Janet Yellen, the head of the Federal Reserve, has warned that social-media firms are overvalued—and has been largely ignored, just as her predecessor Alan Greenspan was when he urged caution in 1999.

Good corporate governance is, once again, for wimps. Shares in Alibaba, a Chinese internet giant that listed in New York in September using a Byzantine legal structure, have risen by 58%. Executives at startups, such as Uber, a taxi-hailing service, exhibit a mighty hubris.

Yet judged by the financial yardsticks of the dotcom era there is as yet no bubble. The NASDAQ index of mainly technology stocks is valued at 23 times expected earnings versus over 100 times in 2000. That year Barron’s, an investment magazine, published an analysis showing that 51 listed technology firms would run out of cash within a year. On December 6th Barron’s repeated the exercise and found only five listed tech firms with wobbly finances.

Instead, today’s financial excess is hidden partly out of sight in two areas: inside big tech firms such as Amazon and Google, which are spending epic sums on warehouses, offices, people, machinery and buying other firms; and on the booming private markets where venture capital (VC) outfits and others trade stakes in young technology firms.
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Take the spending boom by the big, listed tech firms first. It is exemplified by Facebook, which said in October that its operating costs would rise in 2015 by 55-75%, far ahead of its expected sales growth. Forget lean outfits run by skinny entrepreneurs: Silicon Valley’s icons are now among the world’s biggest, flabbiest investors. Together, Apple, Amazon, Facebook, Google and Twitter invested $66 billion in the past 12 months. This figure includes capital spending, research and development, fixed assets acquired with leases and cash used for acquisitions (see chart 1).

That is eight times what they invested in 2009. It is double the amount invested by the VC industry. If you exclude Apple, investments ate up most of the cashflow the firms generated.

Together these five tech firms now invest more than any single company in the world: more than such energy Leviathans as Gazprom, PetroChina and Exxon, which each invest about $40 billion-50 billion a year. The five firms together own $60 billion of property and equipment, almost as much as General Electric. They employ just over 300,000 people. Google says it is determined to keep “investing ahead of the curve”.

Big firms are also making speculative bets, to add new products and insure themselves against technological change. Amazon is investing in content and recently acquired Twitch, a video-streaming firm. Google is throwing cash at driverless cars, robots and home thermostats. Facebook has acquired Oculus VR, a maker of virtual-reality headsets. Mark Zuckerberg, Facebook’s boss, has said that it will not have an immediate payback: “It’s going to take a bunch of years to get there.”

What are the odds of all this money being spent sensibly? Apple is still tremendously profitable. The other firms have patchier records. Google’s return on capital has halved to about 20%, after accounting for stock-option costs. Amazon has never generated much cash. The longer-term omens are not good. Few firms learn how to create a framework for spending tens of billions of dollars almost overnight.

When previous champions, such as Nokia, Yahoo and Microsoft, made big acquisitions in adjacent areas they often fared badly. There are few obvious sources of restraint at those firms still dominated by powerful leaders who control their companies: Google, Facebook and Amazon. All five of today’s stars have lots of excess cash. Much of this is parked offshore and cannot be brought home without incurring tax, giving an extra incentive to spend it.

The second area of technology froth is in private markets. Their exuberance was demonstrated on December 4th when Uber closed a $1.2 billion private funding round that valued the five-year old firm at $40 billion. Baidu, China’s biggest search engine, is set to buy a stake, too (see page 101).

There are 48 American VC-backed firms worth $1 billion or more, compared with ten at the height of the dotcom bubble, according to VentureSource, a research outfit. In October a software firm called Slack was valued at $1.1 billion, a year after being founded. 2014 looks set to be the biggest year for VC investments since 2000 (see chart 2).

Part of what is happening is a shift away from stockmarkets. Entrepreneurs are keen to avoid the bureaucracy involved in initial public offerings. They now have alternative ways to raise cash and to award tradable shares to staff. More institutional investors are buying into private technology firms, alongside VC funds. Unlike in 2000 the firms they invest in already have scale. Uber’s gross sales, of which it keeps about 20%, are expected to hit a run rate of $10 billion by late 2015.

But with many investors chasing a few firms, VC gurus are worried about frothy valuations. The best-known of these, Marc Andreessen, has said valuations are getting “a little warm”, and called for discipline. A banker warns that successful funds’ recent run of profitable exits is encouraging them to take “lottery ticket” bets. Among the most recent tech firms to debut on stockmarkets with huge share-price “pops” are Lending Club, a peer-to-peer lending platform, and New Relic and Hortonworks, two “big data” software firms.

The sins of big, listed tech firms and younger, private ones will be forgiven if their growth continues at a blistering pace for several years: so far there is no clear sign of deceleration. But if these firms do slow down before then, the present investment boom will look like a horrible mistake for the firms and investors that financed it.

For society, though, there is little to fret about. As in 1999-2000, startups and tech giants are creating jobs and investing in new technologies and infrastructure that boost long-term economic growth. But this time round a slump would be unlikely to lead to a broader contagion, since it would be confined to private markets and a few large firms with strong balance-sheets. Silicon Valley still does vanity, bubbles, genius and excess. But when it comes to causing crashes, it has learned to be less evil.

Op-Ed Columnist

Putin’s Bubble Bursts

Paul Krugman

DEC. 18, 2014


If you’re the type who finds macho posturing impressive, Vladimir Putin is your kind of guy. Sure enough, many American conservatives seem to have an embarrassing crush on the swaggering strongman. “That is what you call a leader,” enthused Rudy Giuliani, the former New York mayor, after Mr. Putin invaded Ukraine without debate or deliberation.
 
But Mr. Putin never had the resources to back his swagger. Russia has an economy roughly the same size as Brazil’s. And, as we’re now seeing, it’s highly vulnerable to financial crisis — a vulnerability that has a lot to do with the nature of the Putin regime. 

For those who haven’t been keeping track: The ruble has been sliding gradually since August, when Mr. Putin openly committed Russian troops to the conflict in Ukraine. A few weeks ago, however, the slide turned into a plunge. Extreme measures, including a huge rise in interest rates and pressure on private companies to stop holding dollars, have done no more than stabilize the ruble far below its previous level. And all indications are that the Russian economy is heading for a nasty recession.
 
The proximate cause of Russia’s difficulties is, of course, the global plunge in oil prices, which, in turn, reflects factors — growing production from shale, weakening demand from China and other economies — that have nothing to do with Mr. Putin. And this was bound to inflict serious damage on an economy that, as I said, doesn’t have much besides oil that the rest of the world wants; the sanctions imposed on Russia over the Ukraine conflict have added to the damage.

But Russia’s difficulties are disproportionate to the size of the shock: While oil has indeed plunged, the ruble has plunged even more, and the damage to the Russian economy reaches far beyond the oil sector. Why?
 
Actually, it’s not a puzzle — and this is, in fact, a movie currency-crisis aficionados like yours truly have seen many times before: Argentina 2002, Indonesia 1998, Mexico 1995, Chile 1982, the list goes on. The kind of crisis Russia now faces is what you get when bad things happen to an economy made vulnerable by large-scale borrowing from abroad — specifically, large-scale borrowing by the private sector, with the debts denominated in foreign currency, not the currency of the debtor country.
 
In that situation, an adverse shock like a fall in exports can start a vicious downward spiral. When the nation’s currency falls, the balance sheets of local businesses — which have assets in rubles (or pesos or rupiah) but debts in dollars or euros — implode. This, in turn, inflicts severe damage on the domestic economy, undermining confidence and depressing the currency even more. And Russia fits the standard playbook.
 
Except for one thing. Usually, the way a country ends up with a lot of foreign debt is by running trade deficits, using borrowed funds to pay for imports. But Russia hasn’t run trade deficits. On the contrary, it has consistently run large trade surpluses, thanks to high oil prices. So why did it borrow so much money, and where did the money go?
Well, you can answer the second question by walking around Mayfair in London, or (to a lesser extent) Manhattan’s Upper East Side, especially in the evening, and observing the long rows of luxury residences with no lights on — residences owned, as the line goes, by Chinese princelings, Middle Eastern sheikhs, and Russian oligarchs. Basically, Russia’s elite has been accumulating assets outside the country — luxury real estate is only the most visible example — and the flip side of that accumulation has been rising debt at home. 

Where does the elite get that kind of money? The answer, of course, is that Putin’s Russia is an extreme version of crony capitalism, indeed, a kleptocracy in which loyalists get to skim off vast sums for their personal use. It all looked sustainable as long as oil prices stayed high. But now the bubble has burst, and the very corruption that sustained the Putin regime has left Russia in dire straits.
 
How does it end? The standard response of a country in Russia’s situation is an International Monetary Fund program that includes emergency loans and forbearance from creditors in return for reform. Obviously that’s not going to happen here, and Russia will try to muddle through on its own, among other things with rules to prevent capital from fleeing the country — a classic case of locking the barn door after the oligarch is gone.
 
It’s quite a comedown for Mr. Putin. And his swaggering strongman act helped set the stage for the disaster. A more open, accountable regime — one that wouldn’t have impressed Mr. Giuliani so much — would have been less corrupt, would probably have run up less debt, and would have been better placed to ride out falling oil prices. Macho posturing, it turns out, makes for bad economies.

Russia’s rouble crisis

Going over the edge

A deep recession is now a certainty for Russia in 2015. Things could get much worse

Dec 20th 2014
MOSCOW
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IN THE world of central banking slow, steady and predictable decisions are the aim. So when bankers meet in the dead of night and raise interest rates by a massive 6.5 percentage points it suggests something is going very wrong. It is: the Russian currency crisis many feared is now a reality (see chart) and the mood in Moscow close to panic. Russians are right to worry: they are heading for a lethal combination of deep recession and runaway inflation. 

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Many of Russia’s woes start abroad. The country is highly dependent on its oil-and-gas firms.

Hydrocarbons contribute over half the federal budget and two-thirds of exports. The state has big stakes in many energy firms, as well as indirect links via the state-supported banks that fund them. The oil price has fallen by almost half in the past six months—it dropped below $60 this week, its lowest level since the depths of the financial crisis. The rouble has followed oil down.

The war that Russia has fomented in Ukraine is the second big foreign problem. America and the EU have imposed financial sanctions on many Russian firms, making it hard for them to borrow abroad. On December 12th American politicians agreed to supply weapons to Ukrainian troops, raising the possibility of a further escalation in the conflict. There are plans for further sanctions in the pipeline.

Yet the crisis has now become more general. On December 15th Brent crude barely budged—it dropped by 1%—but the rouble plummeted, losing 10% of its value against the dollar, the worst drop since the previous rouble crash in 1998. The Central Bank of Russia is thought to have intervened, using $2 billion to buy roubles. This did not work, and nor did the midnight rate hike: the rouble lost another 11% on December 16th.

The trigger for this acceleration of the crisis is mysterious. One culprit could be the finances of the state-controlled energy giants, which include Gazprom and Rosneft. Optimists had seen them as a reliable source of dollars. But Rosneft, for one, also has big foreign debts to service or redeem. On December 12th it issued an $11 billion rouble-denominated bond at a lower yield than government bonds were offering that day, which the central bank immediately said it would accept as loan collateral. Some see this as a worrying commingling of government and corporate debt. Around $115 billion in dollar-denominated debt falls due before the end of 2015.

The panic has spread to other assets. The Russian state has around $11 billion in rouble-denominated and $60 billion in dollar debt. The yields on these have risen to 15% and 8% respectively, higher than Greece. Shares in firms exposed to Russia—including French and Austrian banks—are losing value too.

The dollar-debt problem will get worse. Credit-rating agencies including Standard & Poor’s and Fitch were already pessimistic about Russia. With the central bank forecasting a 4.5% drop in GDP in 2015 a downgrade is a certainty. If debt is reclassified as junk, Russia’s investor base will shrink. The volume of debt may jump too. The blurred lines between the state and Russian firms mean the Kremlin may end up on the hook for much of the $614 billion in external debt owed by banks and other firms. No wonder confidence in the prop provided by the Kremlin’s foreign-exchange reserves, officially valued at $370 billion, is draining.

With rate rises and sales of foreign reserves proving ineffectual, Russia needs other options to stem the rouble’s plunge. One would be to try to negotiate extensions to bonds coming due in the hope of trimming demand for dollars, says Tim Ash of Standard Bank. A more muscular option, to which the central bank and the ministry of finance are opposed, is capital controls: the Kremlin could limit people’s ability to convert roubles into hard currency and take it out of the country.

Mr Putin may be inspired by Malaysia, which in September 1998, at the height of the East Asian financial crisis, choked off ringgit speculation by fixing the exchange rate and cutting interest rates. It capped the amount of currency residents could take abroad, and forced foreigners to hold proceeds from ringgit asset sales within the country. But Russia’s economy is in a worse state than Malaysia’s was and its lawless financial system would prove leaky.

Even if Russia does manage to impose capital controls 2015 will be grim. Before this week’s turmoil inflation was running at 9.1%. Now creeping price rises have been replaced by something more ominous: Russian shopkeepers have started to re-price their goods daily. Less than two weeks ago one dollar could be bought with 52 roubles; on December 16th between 70 and 80 were needed. Shops defending their dollar income need a price rise of 50% to offset this. Russian workers’ pay will be cut massively in real terms.

That explains why Russians are losing confidence in their currency. On the streets of Moscow, the talk is all about the crisis. State banks are imposing limits on the amount of dollars and euros they sell. A branch of Sberbank in central Moscow will sell only $2,000. VTB, another state bank, is promising $3,000 but only “tomorrow if you come early and if you are lucky”.

Even if the demand calms (or if bans on using dollars are imposed) Russian banks face huge problems. The shrinking economy, falling inflation-adjusted incomes and massive interest-rate hikes mean that defaults are bound to rise.


Business

How Crude Oil’s Global Collapse Unfolded

Tracing the Plunge In Oil Prices Back to Texas

By Russell Gold

Updated Dec. 12, 2014 6:33 p.m. ET

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 The sudden plunge in global crude oil prices from over $100 a barrel to under $65 has been portrayed as a showdown between Saudi Arabia and the U.S., but the reality is more complex. Associated Press


Since the 1970s, Nigeria has sent a steady stream of high-quality crude oil to North American refineries. As recently as 2010, tankers delivered a million barrels a day.

Then came the U.S. energy boom. By July of this year, oil imports from Nigeria had fallen to zero.

Displaced by surging U.S. oil production, millions of barrels of Nigerian crude now head to India, Indonesia and China. But Middle Eastern nations are trying to entice the same buyers. This has set up a battle for market share that could reshape the Organization of the Petroleum Exporting Countries and fundamentally change the global market for oil.

On Friday, crude prices dropped to their lowest level in five years after the International Energy Agency cut its forecast for global oil demand for the fifth time in six months. That signaled to investors that the world economy would struggle in the coming year, sending the Dow Jones Industrial Average tumbling by 315.51 points, or 1.8%, to 17280.83. That’s the Dow’s biggest weekly percentage loss in three years.

Since June, the IEA has cut its demand forecast for 2015 by 800,000 barrels, while it says U.S. oil output will rise next year by 1.3 million barrels a day.


The drop in global oil prices from over $110 a barrel to under $62 on Friday has been portrayed as a showdown between Saudi Arabia and the U.S., two of the world’s biggest oil producers. But the reality is more complex, involving Libyan rebels and Indonesian cabdrivers as well as Texas roughnecks and Middle Eastern oil ministers. It reflects both the surging supply of crude and the crumbling demand for oil.

And the oil-price plunge may not end soon. Bank of America Merrill Lynch says U.S. oil prices could drop to $50 in 2015.

The roots of the price collapse go back to 2008 near Cotulla, Texas, a tiny town between San Antonio and the Mexican border. This was where the first well was drilled into the Eagle Ford Shale. At the time, the U.S. pumped about 4.7 million barrels a day of crude oil.

In 2009 and 2010, the global economy improved, demand for oil increased and crude prices rose, creating a large incentive to find new supplies. In Cotulla and elsewhere, U.S. drillers answered the call. “There was, for lack of a better term, an arms race for oil, and we found a ton of oil,” says Dean Hazelcorn, an oil trader at Coquest in Dallas.

Today, two hundred drilling rigs blanket South Texas, steering metal bits deep underground into the rock. Once drilled and hydraulically fractured, these wells yield large volumes ofhigh-quality oil; at the moment, the U.S. is producing 8.9 million barrels a day, thanks to the Eagle Ford and other new oil fields.

Americans aren’t pumping more gasoline or otherwise using up all that new crude, and under U.S. laws dating back to the 1970s, it has been almost impossible to export.

As a result, American refineries snapped up inexpensive crude from Texas and North Dakota, using it to replace oil from Nigeria, Algeria, Angola and Brazil, and almost every other oil-producing nation except Canada.

OPEC sent the U.S. 180.6 million barrels in August 2008, a month before the first Eagle Ford well; in September 2014, it shipped about half that, 87 million barrels. That is about 100 fewer tankers of crude arriving in U.S. ports. They went elsewhere.

For a long time, it seemed like the world’s growing appetite for oil would soak up all the displaced crude. By 2011 prices began to hover between $90 and $100 a barrel and mostly stayed in that range.

But earlier this year, another trend began to come into focus, catching Wall Street energy analysts and other market watchers by surprise. In March, many analysts predicted global demand for crude oil would grow by 1.4 million barrels a day in 2014, to 92.7 million barrels a day.

That prediction proved wildly optimistic.


Vikas Dwivedi, energy strategist with Macquarie Research, says a widespread deceleration of global economic growth sapped some demand. At the same time, several Asian currencies weakened against the U.S. dollar.

The cost of filling up a gas tank in Indonesia, Thailand, India and Malaysia rose, just as these countries were phasing out fuel subsidies. In Jakarta and Mumbai, drivers cut back.

“The fact that supply growth was strong shouldn’t have taken anybody by surprise,” Mr. Dwivedi says. But demand for oil “just fell off a cliff. And bear markets are fed by negative surprises.”

Rising supply and falling demand both put downward pressure on prices. Throughout the summer, however, fears of violence in Iraq kept oil prices high as traders worried Islamic State fighters could cut the countrys oil output.

Then two events tipped the market. In late June, The Wall Street Journal reported the U.S. government had given permission for the first exports of U.S. oil in a generation. While the ruling was limited in scope, the market saw it as the first crack in a long-standing ban on crude exports. Not only was the U.S. importing fewer barrels of oil, it could soon begin exporting some, too. This news jolted oil markets; prices began to edge down from their summer peaks.

On July 1, Libyan rebels agreed to open Es Sider and Ras Lanuf, two key oil-export terminals that had been closed for a year. Libyan oil sailed across the Mediterranean Sea into Europe.

Already displaced from the U.S. Gulf Coast and eastern Canada, Nigerian oil was soon replaced in Europe, too. Increasingly, shipments of Nigerian crude headed toward China.

Oil prices began to decline. By the end of July, a barrel of U.S. crude fell below $100. In early September, the IEA, a Paris-based energy watchdog, noted there had been a “pronounced slowdown in demand growth.” A month later, oil prices fell below $90 a barrel.
 
By the middle of September, Petroleum Intelligence Weekly, a widely read industry newsletter, said both sides of the Atlantic Ocean were “awash in oil.” Nigeria, it declared, “needs to find new customers for its light, sweet crude streams in Asia.”

Saudi Arabia didn't want Nigeria to develop long-term relationships with refinery buyers in Asia. In late September, the kingdom decided to shore up its hold on them by, effectively, holding a sale. The Saudis cut their official crude price in Asia by $1 a barrel; within a week, Iran and Kuwait did the same.

Two weeks later, the IEA again lowered its full-year projection of demand growth by 200,000 barrels a day to a meager annual increase of 700,000 barrels, nearly half of what it expected at the beginning of the year. Oil prices fell nearly $4 a barrel on the news.

At this point, the oil market appeared to be in free fall. Of the 23 trading days in October, the price of crude fell by more than $1 on eight days. It rose by $1 on one day. Traders’ attention turned to OPEC, which has traditionally played the role of market stabilizer by cutting production when prices fall and raising production when prices rise. Many OPEC members, reliant on the cash oil brings in to pay for generous social programs, didn’t want to cut.

Saudi Arabia’s powerful oil minister, Ali al-Naimi, was silent for weeks. The country had been burned in the past when it cut its oil output, only to see other countries continue to pump—and steal its customers.

And it was already feeling competition, says Abudi Zein, chief operating officer of ClipperData, a New York firm that tracks global crude movement. Colombia, which historically has sent most of its oil to the U.S., is finding its biggest buyer this year is China, a critical market for OPEC, he said.

“For the Saudis, Asia is their growth market,” Mr. Zein says. “The Nigerians and Colombians are being kicked out of their natural markets in North America. Saudi had to do something.”

At its regular meeting in Vienna in late November, the cartel kept production unchanged. U.S. and European oil prices fell another $7 per barrel.

On Wednesday, Mr. al-Naimi, the Saudi Arabian oil minister, was asked whether OPEC would soon act to cut exports. “Why should we cut production?” he asked. “Why?”