South Africa's M3 now buys less Coffee, gold and other stuff; did Bernanke dilute our whiskey?

The previous two articles I did on the purchasing power of residential property, and the JSE Top 40 got me wondering: how much value could we purchase if we were to trade in the entire South African M3 money supply for commodities? I compiled some graphs and found the answer to be very interesting.    

So, if we were to trade M3 for commodities; would we get more, or less in commodities?  That is the question I attempted to answer in this posting.

M3 Money Supply

To provide a bit of background; M3 refers to the broadest measure of the amount of money in circulation in an economy (this is according to Investopedia.com). Simply put our M3 money stock is a measurement of all the cash and electronic money available in the South African economy; our entire supply of money. 

It is an accepted fact that the central banks of the world are able to expand monetary bases (print money). That means that governments, along with their central banks, can manipulate the amount of money that circulates in their economies.

The US is a good example; and man have they expanded their money supply since the big financial crisis of 2008. Take a look at the following chart of the monetary base of the US (this provides an estimate of the cash in hand and money at reserve at the US banks, i.e. their monetary base). 

Adapted from data: http://research.stlouisfed.org/fred2/categories/32345

Wow! I think it is rather obvious that Uncle Sam has been printing a lot of money since 2008.

But what about the situation closer to home, in good old South Africa. What has our monetary base been up to? Have we 'created' any money?

To find out, I compiled the following graph, subtracting M1 base currency (notes and coins) from M3 money supply. I wanted to see if any money was created in a broad sense (apart from notes and coins). So let's see: 

Adapted from data: http://research.stlouisfed.org/fred2/categories/32345

I think I am correct in saying we had a nearly parabolic increase in the RSA money supply since 1999/2000.

[Also: notice the extreme volatility present in the chart from 2008 to 2010, which have coincided with the financial crisis].

But, are there any negatives to extensive money creation? Well yes, there may just be one; a monster named INFLATION. I don't think inflation should become a problem if we had real inflows of real wealth into a country. But if the money was created from nothing, inflation must be expected.

You may gather that I don't trust this money printing business much, it's a personal gripe.  But, many economists argue that money creation only becomes a problem when it leads to  excessive inflation. And hey, the guys managing our global economy know what the're doing, right?

But money creation requires us to keep a tab on inflation and we have to measure inflation against something. So, how do we typically measure inflation? We typically use a measure called the Consumer Price Index (CPI).

I inherently distrust the CPI

Note: my personal distrust of CPI flows from a perceived problem of incentives.  Governments that print money should be expected to have vested interest in reflecting low measures of inflation.  By understating inflation governments could increase the money supply more, thereby funding government obligations and liabilities, through money creation - without raising taxes (A less controversial policy choice). 


The Corrupt Barman


Think about a corrupt barman, diluting the bottle of Johnny Walker behind the bar; while still  charging you yesterday's price for your tot of whiskey. That should give you a fair idea of how inflation works, less bang for your buck! 


Low CPI may mask the actual destruction of purchasing power through excess money creation and corresponding inflation. Some call inflation brought about in such ways 'stealth taxation'. So, I am saying that governments may have very real incentives to understate inflation, especially the CPI, and that's why I don't trust it.


Within this context, I decided to measure the value of South Africa's M3 Money stock in commodities. The basic question asked was:  how much value could we purchase with our M3 money stock when we measure the value of M3 commodities (not in Rand)?       

How much, in commodities, would our entire stock of M3 have purchased?  

Ok, so let's say we have gone completely insane and decided to trade in the entire M3 money supply of South Africa for different commodities. What then would our M3 be worth in commodities?

The following series of charts, I compiled, will give you an idea of the value of our M3 stock over the past 20 years measured in things like gold, silver, maize, soy, and fuel. I used the data gathered from http://www.indexmundi.com/ for this analysis.
Our M3 data was gathered from:
http://research.stlouisfed.org/fred2/series/MYAGM3ZAM189N?cid=32345.  

I have divided the commodities into 5 categories, in an attempt to make the information easier to digest. 

[I am not suggesting that the uses described for the commodities in the categories were exclusive. They were merely chosen for broad categorization purposes]. The categories were chosen as follows:   

Stuff that shines: Gold and Silver

Stuff to eat: Food

Stuff the build with: Wood, Steel, Copper   

Stuff to travel with: Energy and Fuel

Stuff to grow other stuff with: Fertilizers 

1. STUFF THAT SHINES

Gold

Gold has had a staggering growth in price over the past decade. This growth is reflected in the chart above. In 2005 our M3 money stock would have purchased about 350 million oz of gold.

By the end of 2011 M3 was valued at only about 150 million ounces of gold. A drastic decline of 57.14% Notice that measured in gold, our M3 has appreciated in value from 1980 until 2005/2006. It started to depreciate in value from 2006 onward. Yes indeed, M3 now buys less in gold.  

Silver

   

   

Silver has historically been a more volatile investment than gold. So how much silver could our stock of M3 have purchased over the last couple of years? 

M3 money stock in oz of silver

January  2005:    22.9 billion oz of silver

January  2009:    19.5 billion oz of silver

August   2011:       7.6 billion oz of silver  

A 67% drop from the high in 2005; M3 now buys less silver. So, in Gold and Silver - real money - our M3 money stock has declined in value.

Next up I'll consider 'stuff we eat', M3 valued in food prices. 

2. STUFF WE EAT: FOOD

Bananas

M3 Money Stock in Tons of Bananas:

January 2005:       404 million tons

December 2007:  378 million tons

January 2009:       213 million tons

August 2011:        319 million tons

Compared to the high of 2005 our money stock appears to be valued somewhat less in banana (404 tons to 319 tons).  Overall, the chart seems to have stayed within a broad trading range.      

Beef

Our M3 money stock measured in pounds of beef: 

April 2008:        221 billion pounds

August 2011:   169 billion pounds

From June 2002 to round about January 2008, we find that M3 has appreciated in beef (reflected an up trend). From January 2008 to August 2011 it appears that M3 has started to  depreciate when measured in beef. Has M3 started to lose value when measured in Beef? 

Chicken

Our M3 money stock appears to have appreciated in value, measured in chicken. The trend appears to be a trend of appreciation.  I found this very interesting, maybe one of our readers could tell us why M3 would show such a continual appreciation when measured in chicken.

See the actual data below:

Our M3 money stock measured in pounds of Chicken  

April 2006:             294 billion pounds of chicken

December 2007:  319 billion pounds of chicken

August 2011:         346 billion pounds of chicken

Maize

Maize appears to be another highly cyclical commodity. This is reflected by the highs and lows of the chart. However, the drop in value from June 2010 to Aug 2011 appears to be very pronounced. A depreciation trend might also have formed since 2005 (where M3 started to show a general decline in value when measured in maize).

Keep in mind that maize is an important ingredient in much of the industrial food production industry.  We should thus expect rising maize costs to have a knock-on effect on the prices of other food stuff. 

M3 Money Stock measured in Tons of Maize: 

April 2006:     1.85 billion tons

July 2007:       1.50 billion tons

Jun 2008:        803 million tons

Jun 2010:        1.70 billion tons 

Aug 2011:       987 million tons

Coffee (Robusta) 

Next up my favorite commodity. It appears that M3 measured in coffee has declined significantly also since 2004.

M3 measured in Pounds of Robusta Coffee:

October 2004:    450.3 Billion pounds of coffee

March 2008:       178.6 Billion pounds of coffee

Wheat

Looking at M3 measured in wheat a short-term pattern of depreciating value appears to exist. Wheat was relatively cheap in 2005 and 2010, increased in price during the big financial crisis of 2008.  Now our M3 money stock buys less wheat than in 2010 and 2005.

M3 Measured in tons of wheat
Apr 2006:     1.1 billion
Mar 2008:    497 million
Jun 2010:     1.6 billion
Aug 2011:     936 million

Soybean

Measured in soybean, our M3 money stock has also shown a decline in value especially since April 2006.

M3 measured in tons of soybean
Apr 2006:    952 million
Jul  2008:     441 million
Mar 2010:    756 million
Aug 2011:    626 million

Sugar

Sugar is another important element in the western industrial food chain (perhaps to our detriment). When measured in sugar, we see that M3 has steadily been declining in value since 2006/2008

Sunflower Oil

Sunflower oil shows an interesting and volatile trend. Our M3 money stock was worth a lot in sunflower oil from Jan 2006 up to about Jan 2008. However, since Jan 2008 M3 seems to have been declining in value when measured in sunflower oil.

So let's look at some commodities used for building processes.

3. STUFF WE BUILD WITH

Wood: soft logs

At this point it seems like M3 remained relatively stable and appreciating, when measured soft logs.

Copper

M3, when measured in copper appears to have been declining in value.  Since the first semester 2009 M3 has dropped very much in value when measured in copper.


Wood: hard logs

Hard logs tell a story of depreciating value. M3 measured in hard logs spiked in 2010 where M3 was valued at 1.085 billion cubic meters of hard logs.  In August 2011 M3 would have bought only 680 million cubic meters of hard logs.

That is lower than the average value which existed between June 2004 to July 2008. It appears that M3, measured in hard logs, is declining in value. The trend may even be reversing to a trend of depreciating value.

Hot Rolled Steel

M3 measured in hot rolled steel has declined slightly since 2010.  The chart seems to reflect increasing volatility.  At this point M3 still buys a lot of hot rolled steel. However, if global production was really in an uptrend (as the news services would like us to believe) shouldn't this chart reflect a decline in value as hot rolled steel becomes more expensive? Which it has not.  

STUFF WE USE TO GROW STUFF WITH

Triple-Superphosphate and Potash

Next up, let's look at two common types of fertilizer used in the agricultural sector: Triple-superphosphate and Potash.

The charts below seems to indicate that our M3 money stock, measured in these two fertilizers, is worth less than it was during the period of 2002 to 2007.

STUFF TO TRAVEL WITH

Gasoline, Crude Oil, and Jet Fuel


The following three charts appear to be nearly identical. M3, measured in these three fuel commodities, moves in a sideways range from 2000 to 2008. It then jumps in value during  2008/2009 and then starts to decline (implying M3 being worth less when measured in fuels).

Notice than our M3 money stock would have purchased much more fuel in 98/99 compared to today. Jip indeed, fuel has gotten more expensive. And we are due for another increase this week.  

It's Index Time !!!


My final chart is an index I compiled from 21 commodities considered so far for this posting.  I simply added all the aggregates of M3 measured in various commodities together and divided by 21 for each year.  In theory, this should give us a sample of the general value of our M3 money stock measured over a population of commodities.

I used MS Excel to include a polynomial trend line on the chart. The trend line seems to agree with the general idea that more money printing will devalue the money stock in purchasing power. 'Curiously' the start of the depreciation of M3 found on the chart corresponds rather nicely with commencement of the US Federal Reserves Quantitative Easing programme.

 

Note that this research has various limitations.  I am tentatively proposing in this posting that a further decline in the value of M3 may be likely. But additional research is needed on this topic. Maybe by people paid to do this full-time. 


Conclusion

I have attempted in this posting, to show that even with big increases in money supply, both in local and US money supply, we may not be better off. It appears that our money stock has declined in value when measured in many of the commodities considered. Perhaps the old maxim that 'throwing money at problems rarely solves anything' is indeed true.

Troubling to me is the high depreciation of M3 when measured in wheat, maize, soy and sunflower oil and sugar. Over the long-term, M3 may also be declining in value when measured in oil, fuel and other fossil fuels (which seems to give support to the idea of appreciating energy prices and peak oil). If my results are true, we should expect to pay more for many things.

Our Johnny Walker, has been diluted!

Some commodities have not reflected a decline in value at this point; specifically chicken, beef, banana, soft logs, and hot rolled steel.

To venture a guess on whey that is: beef and chicken may still be heading for a decline, spurred by the higher input costs of wheat and maize. The polynomial trend-line for beef seems to be pointing down. Hot rolled steel has application in construction and in the US, for example, total construction spending has declined since 2006. I expect this to be a global trend. Logically, I would expect prices of this commodity to be low at present, representing more value.

Measured in real (non-fiat) money; specifically gold and silver - our M3 money stock has declined much in value. I think it is fairly accurate to suggest that M3, now is worth less than it was before the big economic crisis of 2008.

To conclude then, it seems to me like all the global money printing has not made us better off. South Africa as a whole may now have to accept buying less bang for our buck. We may have to deal with the diluted Johnny Walker, what do you think?

Posted by Gerhard van Onselen (follow me on Linked In and Twitter)

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Disclaimer:

I am not a professional financial adviser. Information presented is intended to be solely conversational and educational, please don't make investment decisions based on just one source, do your own research, and consult a registered financial adviser.While I tried my best to present accurate information and numbers in this posting, I cannot guarantee the accuracy of any information presented.    

Is the 'Silent Stock Killer" Hunting our stock portfolios? A look at the fundamentals of the TOP 40 Index

In my previous post I suggested that the JSE Top 40 Index may be heading for a crash. I looked at a very long run technical chart that suggested that the SA stock market is basically on the verge of  massive crash. 

Have I been proven wrong? Short term coverage seems to say so.  In a technical research chart, released yesterday, by one of the big brokerage houses in SA, it was indicated that the JSE Top 40 index had broken a historic technical resistance level. 

Such a confirmed breakout suggests a very positive upward move for the market, which does not look good for my previous technical analysis.  Yet, in all fairness, yesterday's move still has to stand the test of time.  So we'll just have to wait and see.  

However, I am still concerned about the index. In today's post I want to present the findings of some research I did on the Top 40's fundamentals. What I did was to analyze the historic Price to Earning multiples of 39 of the 42 Top 40 shares. I also looked at earnings per share (EPS) histories of 22 of the 42 shares (selection favored shares with 10 years or more EPS  and PE histories). 

I used these numbers to develop annual PE multiples and an average annual EPS histories*. 

A bit of context ...  

But first a bit of context: briefly explained the PE multiple/ratio indicates how much investors are willing to pay for the earnings of a company. For example a stock with R1-00 EPS and a PE multiple of 10 will have a market price of R 10-00 on the stock market. A stock with a PE or 15 will cost R 15-00, and a stock with a multiple of 5 will cost R 5-00.   

Why is this important? Certainly for many reasons, but in this post I want to look at ways how a share's price can fall in the context of PE and EPS. 

Basically, there are two ways for a share to drop in market price 1) through a shrinking EPS and 2) through a shrinking PE.

Lets say the share in our example above still has a PE multiple of 10 but the EPS shrank to 50 cents; now our share will be valued at R 5-00 (10 x R 0.5).  Or, lets say the share's EPS is R 1 but the multiple shrank to 5, in such a case the share is also valued at R 5-00. Both a drop in EPS or a shrinking multiple imply a drop in the market price of shares. 

But, what happens when the both the EPS and the PE shrinks? Lets say our share has an EPS of R 0.5 and a PE of 5, in such a case the share will be valued at only R 2.50 (R 0.5 x 5). The reverse is also true; shares may go up in value when the PE multiple expands or when earnings expands. 

To profit in stocks

So, to profit in stocks it is necessary to watch the PE multiples and EPS of stocks carefully. Note that markets trade a different multiples at different periods of time.  

Jim Cramer of CNBC's Mad Money explains that the multiple is expected to shrink when interest rates are raised and is expected to expand when interest rates are lowered. 

Why? Simply because savers (e.g in the money markets) and bond holders earn greater profits in high interest rate scenarios. When interest rates are raised, the risks associated with stocks look less appetizing to investors. Consequently investors downgrade the valuation on stocks resulting in lower PE's (all things being equal).     

Beware of the 'silent stock killer'

A shrinking multiple can kill the market prices of stocks, even when earnings (EPS) remain stable. Cramer calls the shrinking PE multiple the "silent stock killer".  If both earnings and the PE multiples shrink stock investors may be in for a double whammy!

So, now that the stage is set it is time to consider the following chart of the TOP 40's averaged PE Multiples since 1992. I used the data obtained from Standard Bank OST for my calculations.  I averaged the annual PE's of 39 stocks for each year since 1992 and plotted the data on the chart below: 

Click to Expand

The numbers I ran seem to suggest that since 2003 the Top 40 has expanded from  a PE of 9.1 to a PE of 15.6 prior to the 2008 market crash. During the crash the PE multiple shrank to  9.8. Thereafter, the multiple expanded again from 9.8 to 16.5 in 2009 -2010. However, the last numbers available to me shows that the multiple has since 2010 to date again started to shrink. The average multiple at 2011 was at 15.1 close to the mean average of 14.4.    

So it is likely that the Top 40's PE multiple may be declining.

But, what about the average EPS? To answer, I did a similar exercise averaging the annual EPS of 22 of the 42 companies of the Top 40. 

[Note that we have to interpret these numbers with caution since it is a smaller sample and the 2011 earnings data for many of the companies are not available yet. I had a sample of 12 companies for 2011's to work with. So the EPS average, in this case, might not be as reliable. However, the sample does point to the possibility that the earnings of the Top 40 companies may be under pressure for 2011].  

Refer to the chart below:

Click to Expand

Notice that for 2010 the average EPS was R 9.44 and for 2011 it was 9.33; suggesting a potential drop in EPS. 

The Repo Rate at 5.5 % is very, very low 

Next, we have to consider interest rates. To do this looked at the RSA Repo Rate.

According to Liberta.co.za the "Repo Rate is the rate at which commercial banks can borrow money from the Reserve Bank".

In a crude explanation of the Repo Rate's function, we can say that the lower the Repo rate, the more people and companies can afford to borrow, and the greater the supply of money will be in South Africa.

So, at low interest rates, more money is available to chase goods, services, and investments (such as stocks).  

Testing Cramer's idea mentioned above; I have plotted the average annual PE's of the TOP 40 (in red) along with the averaged annual RSA Repo rate (in blue) on the chart below.  

Click to Expand

The following things struck me looking at the chart. 1) The Reserve Bank has dropped the interest rates to a historic 10 year low in response to the 2008 recession.  

[It seems to me like they cannot drop rates by much more. At some point they have to start raising rates or face run-away inflation produced by all the excess money supply that has been created].  

2) Even at the historically low interest rates the Top 40's PE Multiples had still started to indicate possible decline. 

How is this possible I wonder? If the market is facing a PE decline in the low interest rate scenario, what will happen if the Reserve Bank starts to raise the Repo rate (which they have to do at some point).  

In conclusion ... 

This posting concludes a number of posts I did on the economy and 2012.  When considering stock investments I like to think in terms of upward pressure and downward pressure.  The question we have to ask ourselves is which on the of the two pressures are more likely to win.  My bet is that downward pressure will win in the medium to long term.

It is clear to me that we may be facing a possible scenario of shrinking of PE multiples, which may erode the market price values of shares, even if earnings remain stable (which appears not to be the case). My research also seems to suggest that corporate earnings may be coming under pressure again. If both earnings and PE's comes under pressure, buying and holding shares may not be a good idea. 

Many may disagree with me, but I think that the JSE is being kept alive on stimulus through low interest rates and global money printing, not through actual value. In value the index may have actually declined.

Will the market's prices follow suit, I guess only time will tell ... 

Posted by Gerhard van Onselen. Follow me on Twitter, Linked In or Google Plus. 

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Disclaimer:

I am not a professional financial adviser. Information presented is intended to be solely conversational and educational, please don't make investment decisions based on just this  source, do your own research, and consult a registered financial adviser.

While I tried my best to present accurate information and numbers in this posting, I cannot guarantee the accuracy of any information presented.