Egyptian Pound Update

Reuters:  IMF team to arrive in Egypt on Wednesday for loan talks
"(Reuters) - An IMF delegation will arrive in Egypt on Wednesday for talks with the government on a USD 4.8 billion loan...Spokesman Alaa El Hadidi added that Egypt would not seek any emergency loan from the International Monetary Fund and faced no "crisis" in funding the import of essential commodities...Reserves of foreign currency have fallen to critically low levels, threatening Egypt's ability to buy in supplies of wheat, of which it is the world's biggest importer, and fuel...Hadidi, seeking to allay public concerns over power cuts and long queues at petrol stations, ruled out an emergency loan, as suggested by the IMF. He added that the country was still able to buy essential imports..."(The supply) of wheat and loaves of bread is safe," he told reporters. He added that indications of a higher harvest this year meant Egypt would use locally-grown wheat in the place of wheat that would otherwise have been imported."

NYT:  Fuel shortage puts a strain on Egypt
"US officials are warning of disaster unless Egypt soon carries out a package of tax increases and subsidy cuts tied to a USD 4.8 billion loan from the International Monetary Fund. That would persuade other lenders that Egypt was creditworthy enough to obtain billions more in additional loans needed to meet its yawning deficit...Egypt has held two years of unsuccessful talks with the IMF, and the current government is still balking at the politically painful package of overhauls — even as rising prices and unemployment make those measures more difficult with each passing day...“They are operating on the notion that Egypt is too big to be allowed to fail, that the US and the West will step in,” Shimy said. “They think Egypt has a right to get the loan, and I think they will probably keep pushing all the way.”...Officials of the Morsi government have indicated that they prefer to wait until the election of a new Parliament, which might demonstrate broader public agreement on the need for changes. But a court decision striking down the election law has postponed the vote until at least the fall, and many economists say Egypt cannot endure the delay...Energy subsidies make up as much as 30 percent of Egypt’s government spending, said Ragui Assaad, of the Economic Research Forum here."

The official exchange rate has has remained under control  (see here)

 However assuming this report is correct, the market is not really at 6.80 but rather at 7.55 EGP per USD.

"The recent jump in prices is an indication of a black market that is drying up due to higher demand than supply, one banker who declined to be named said...“Clients who work on parallel markets confirm that prices jumped. This is a major leap that happened in the past three days because of the lack of availability,” he said...“It is not dry yet but it is not as liquid as it was ... It is quite possible for the dollar to reach 8 pounds or even higher if the problem continues,” he said.

Is the Morsi government really going to bring their finances to the brink and hope the US / Europe / Gulf States bail them out?   Or is he looking for political cover before making hard budget decisions?

Israel Gas Roundup

NYT:  Israel Begins Pumping Natural Gas From Offshore Field
"Israel’s Ministry of Energy and Water Resources says that the Tamar field will supply 50 to 80 percent of Israel’s natural gas consumption needs over the next 10 years. About 40 percent of electricity in Israel has been generated from natural gas in recent years, and the rate of natural gas consumption is expected to rise to 50 percent by 2015, the ministry said."

As the article notes the Tamar gas field went on line yesterday.  Tamar is estimated to hold 275 MM cubic meters of gas.  The larger Leviathan field (also see here here and here) is estimated to hold up to 700 BB cubic meters of gas, 600MM barrels of oil, and unknown amounts of natural gas condensates.  This is not a huge amount by world standards (less than 0.5% of world proven gas reserves)  but Israel's population is only 0.1% of the world total.  A comparison which brings together two stories that we have been following.  Israel's proven gas reserves are approximately 10% larger than Pakistan's reserves.  However Pakistan's population is approximately 23! times as large as Israel's.

At one time there was discussion of a deal for Gazprom to export LNG from Leviathan but now it appears that Australia's Woodside Petroleum will get that stake (see here).

Iran-Pakistan Pipeline (the US is not pleased)

Over the last few months we have written a few times about

• sanctions against Iran (here here)

•  Pakistan's natural gas shortage   (here here here)

It seems only natural that the two issues would eventually collide ...To review

Iran has the world's fourth largest oil reserves and second largest natural gas reserves and yet says they need nuclear power for civilian purposes.   Most people believe that they are in fact trying to build a nuclear weapon.  The US and EU have imposed an embargo on Iranian oil and threaten to blacklist any banks of any country that does not cut its imports of Iranian oil.

In the early 2000s the Pakistani government made a concerted attempt to shift their automobile energy source from oil/gasoline to compressed natural gas (CNG).  In order to promote this switch the government set the price of CNG very low. The policy succeeded.  80% of their automotive fleet (3.5MM units) now run on CNG.  Pakistan is now running low on CNG and power / industrial users are competing with gas stations for supply.  At current utilization rates Pakistan will exhaust their proven natural gas reserves by 2020.

Here are the developments over the last few weeks

DAWN:  (March 1, 2013) Groundbreaking of gas pipeline on 11th
'After a wait of almost two decades, the groundbreaking of UD 7.5 billion Iran-Pakistan gas pipeline will be performed on March 11 on the Pak-Iran border by the presidents of the two countries...President Asif Ali Zardari returned on Thursday after a two-day visit to Iran for finalising the gas pipeline deal and sorting out financing and technical issues.  In Tehran, President Zardari, while rejecting the US pressure, had said: “We deeply believe in boosting bilateral ties. The international and regional players have tried in vain to prevent expansion of Iran-Pakistan ties but the people have learnt how to act against the enemies of Islam.”...Tehran has agreed to provide a USD 500 million loan to partially finance construction of the pipeline on the Pakistan side, which will cost USD 1.5 billion. Pakistan will pay the remaining cost from its own resources...If everything else goes well the pipeline will be completed in 15 months. Iran has already completed the pipeline in its territory, while the laying of 785-km-long Pakistani section will commence now. Pakistan plans to import 21.5 million cubic metres of gas daily from Iran via the pipeline."

DAWN: (March 5, 2013) Zardari seeks to allay US concerns
"Allaying concerns of the United States over the USD 7.5billion Pakistan-Iran gas pipeline project, President Asif Ali Zardari said on Monday that Pakistan did not intend to offend anyone by pursuing this project of national importance...“Let me tell you, Pakistan does not want to offend anyone. It is a sovereign country and has every right to pursue projects in its national interest,” ..The US has warned that the pipeline deal, if finalised, would raise serious concerns."

(btw I am sure that his "enemies of Islam.” comment was not meant to offend anyone.)

DAWN: (March 7, 2013) Islamabad to complete Iran-Pakistan pipeline ‘despite US pressure’
Pakistan will complete the USD 7.5 billion gas pipeline from Iran to Pakistan despite pressure from the United States, a spokesman for the foreign office said Thursday...It will be Zardari’s second visit to Iran since February 27 and comes after officials said a consortium would start work on the pipeline on Pakistani territory on March 11 despite American warnings of possible sanctions...Pakistan suffers from a crushing energy crisis, but the United States is pushing Islamabad to use its offered alternative solutions to help avoid sanctions...Although the pipeline on the Iranian side has almost been completed, Pakistan has run into repeated difficulties, both in financing the project and over a US threat of possible sanctions due to Iran’s nuclear activities...Iran eventually agreed to finance a third of the costs of laying the pipeline through Pakistan, with the work to be carried out by an Iranian company."

DAWN: (March 11, 2013) Pakistan stock market plummets over Iran pipeline sanction fears
"The Karachi Stock Exchange (KSE) benchmark 100-index ended 441.62 points, or 2.46 per cent, lower to close at 17,522.56 points...“There was a panic-like situation in the market as investors fear United States may impose economic sanctions on Pakistan because of the gas pipeline,” said analyst Mohammad Sohail of Topline Securities...“The market experienced turmoil all the day. It never recovered till it suspended trading.”..Brokers said selling was witnessed across all stocks...Pakistani analysts said a statement from the US State Department was expected later in the evening, which could determine the future course of the market...US State Department spokesperson Victoria Nuland has warned if the deal is finalised, it “would raise serious concerns under our Iran Sanctions Act.”

Reuters:  (March 11, 2013) Pakistan starts work on Iranian gas line opposed by U.S.
Pakistan's stock market closed lower on Monday after the gas pipeline deal with Iran raised fears the United States would impose sanctions on Islamabad, dealers said...Asked if she wished to calm those worries, U.S. State Department spokeswoman Victoria Nuland bluntly told reporters in Washington: "I would not like to allay those fears.  If this project actually goes forward we have serious concerns that sanctions would be triggered," she added. "All of that said, we've heard this pipeline announced about 10 or 15 times before ... so we'll have to see what actually happens."...Pakistan has pursued the pipeline scheme as a way of alleviating severe energy shortages that have sparked demonstrations and battered a weak government. At the same time, it badly needs the billions of dollars it receives in U.S. aid..."The Pakistani government wants to show it is willing to take foreign policy decisions that defy the U.S., particularly when such crucial issues as energy security are at stake," said Anthony Skinner, a director of British-based Maplecroft risks consultancy.  "The pipeline not only caters to Pakistan's energy needs, but also lodges brownie points with the many critics of the U.S. amongst the electorate," he told Reuters....The project faces security challenges posed by ethnic Baluch militants who have demanded greater control over Baluchistan's natural resources, and by Iranian Sunni insurgents also based in Pakistan who are fighting for greater rights in Iran..."Having a pipeline running through the region makes it particularly vulnerable to bombings and disruption," said Skinner. "Washington could bolster its support for local elements, causing significant disruption to pipeline infrastructure." 

DAWN: (March 13, 2013) ‘Gas pipeline dispute may not lead to US aid cut-off’
"The United States might not stop economic assistance to Pakistan over the Iran gas pipeline but the project would seriously strain relations between the two countries, diplomatic sources told Dawn...“The project will create lot of bitterness towards Pakistan, which Pakistan does not need,” said one source, noting Osama bin Laden’s discovery in Abbottabad had already tarnished Islamabad’s image in the United States...“The worry about Iran’s nuclear programme is real enough — and the perception that Pakistan may be helping them to make more money to evade international sanctions will further damage Pakistan’s stock here,” the source said."

UPI:  (March 13, 2013) Iran pipeline to Pakistan tests U.S. stand
"Although Iran won't feel any economic benefit of the deal for some time, Tehran can chalk up one in the eye for "the Great Satan" as it seeks to throttle the Islamic Republic's energy exports, its economic mainstay...Monday's inauguration of Pakistan's participation in the much-delayed project is the first substantial defiance of Washington's campaign to cripple Iran's economy until Tehran abandons what the Western powers see as a drive to develop nuclear weapons...Middle East analyst Kaveh L. Afrasiabi observed that the pipeline deal is also "a timely break for Tehran, which is reeling under Western economic pressures..."It weakens the politics of leverage at nuclear negotiations with Iran which are currently at a turning point," he wrote in Asia Times Online this week...The dilemma the Americans now face, he noted, "is how to look for a greater stability role from a country that it is now threatening with (collateral) sanctions under the U.S. Sanctions Act."...Lastly, there are U.S. concerns that India, which was part of the project when it was mooted in 1994 but withdrew under U.S. pressure in 2008, might decide to defy the Americans as well...India, like Pakistan, its longtime regional adversary, desperately needs to boost its energy supplies to meet the demand of its burgeoning industrial sector and population."

Here is more from Wikipedia on the Iran-Pakistan Pipeline

In a related note Pakistan's parliament made it through a full five year term without being deposed.  This is a first.

DAWN:  (March 17, 2013) Days of mischief against democracy over, hopes Raja: 
"The PPP-led federal coalition bid a historic farewell on Saturday as Pakistan’s first elected government to complete its parliamentary term, with Prime Minister Raja Pervez Ashraf voicing his confidence that it would mark the end of a “sinister chapter” in the country’s history of ambushes on democracy.  The term of the government was linked to the expiry of the five-year term of the 342-seat National Assembly at midnight, though the prime minister might hang on for about a week until a caretaker successor takes over to oversee the next national elections within two months...The term of the National Assembly, elected in a 2008 vote that dealt a death knell to about nine years of military-led rule of Gen Pervez Musharraf, began with oath-taking by its members on March 17, 2008, though the coalition government, then headed by prime minister Yousuf Raza Gilani and also including PML-N, took office eight days later on March 25."

The Stalking Horse and the Triumphant Return of the Ding Dong!

NYT:  Hostess Sells Twinkies Brand to Investment Firms
"Twinkies and Ding Dongs are back from the dead...Hostess Brands, the now bankrupt owner of the cream-filled confections, agreed on Tuesday to sell the snacks — along with Ho Hos, Sno Balls and Dolly Madison Zingers — to two investment firms with a shared history of corporate turnarounds...The deal, worth USD 410 million...The new owners will be Apollo Global Management and Metropoulos & Company, which owns Pabst Blue Ribbon and Vlasic pickles...Apollo and Metropoulos emerged from what at one point seemed like a crowded field of bankruptcy bidders for the brands. At one point, more than 100 parties had expressed interest in Twinkies...But by 5 p.m. Monday, the deadline for bids, the only qualified offer came from Apollo and Metropoulos. Advisers to Hostess canceled an auction scheduled for Wednesday morning and declared the two the winner.  “It’s not that we lacked interest,” Gregory F. Rayburn, the Hostess chief executive, said in an interview. “Other bidders felt that they could not top the price.”...Hostess is still selling its other remaining brands, including Drake’s snack cakes. Those auctions are expected to conclude by early next month."

How exactly did this auction work?

CNBC:  'Wild and Woolly' Twinkies Auction Expected: Hostess CEO     Jan 31, 2013
"The bids for Twinkies and the other snack cakes of bankrupt Hostess Brands will be intensely competitive, company CEO Greg Rayburn predicted in a "First on CNBC" interview on Thursday.  Hostess has chosen a baseline offer of USD 410 million from private-equity firms Apollo Global Management and Metropoulos & Co. to purchase the brands, five bakeries and certain equipment...The so-called "stalking horse" bid by the private equity firms to buy the 82-year-old baker would serve as the minimum offer...Others bidders could still offer more at an auction that Hostess plans to hold next month — pending authorization from the U.S. Bankruptcy Court for the Southern District of New York. "

so the "stalking horse" Apollo made their bid known and then there was a court run auction to see if any other parties could top that bid?   However in the end no one wanted to top USD 410 MM.   Why do you want to conduct an auction in this manner?

Here is a description of some standard types of auction mechanisms

There are two potential obstacles to using standard auction mechanisms in bankruptcy proceedings (1) there may be a substantial fixed cost for a bidder to value the assets.  Hence a bidder will decrement his valuation by the cost of gathering the information.  Furthermore a potential bidder may choose not to participate at all if the cost of gathering the information is significant and the probability of winning the auction is low.  (2) there may be great uncertainty as to what the assets are worth.  If one conducted a sealed first price auction then bidders would have no opportunity to confirm their valuations from the valuations of other bidders.  Since the risk would be higher bidders would decrement their bids.  If one conducted an English first price auction then there would be an opportunity to see how others value the asset - on the other hand the first bidder is still at risk of going out on a limb and having no one else bid.  The stalking horse mechanism guarantees at least one party will bid on the asset and also sets a public reference price for the asset.

so why would anyone want to go out on a limb and be the first public bidder ie the stalking horse


from here is a description of an auction with a stalking horse

""Incentives for the stalking horse - Potential purchasers may be reluctant to take on the role of the stalking horse for a variety of reasons, preferring instead to wait for another bidder to negotiate the deal and then participate in the auction. The initial bidder typically has to expend greater resources than other bidders in negotiating the deal, performing due diligence, and otherwise setting the "floor" for the terms of the transaction. To compensate the stalking horse for its time and effort, certain incentives are typically negotiated. Without receiving these incentives, the potential purchaser would not otherwise agree to be the stalking horse. These incentives may include expense reimbursements, break-up fees, favorable bidding procedures, and exclusivity arrangements. The incentives requested by the stalking horse are often at odds with the debtor's duty to obtain the highest and best value and the requirements of the bankruptcy code. The negotiations between the debtor and stalking horse must strike an acceptable balance, or the bankruptcy court will likely not approve the stalking horse's proposed terms."

Who knew that Twinkies and Ding Dongs could be so educational?

India's Golden Years

Economist:  India’s lust for gold - Treasure chest - Love of gold becomes a macroeconomic problem
"Sadly, India’s gold obsession is no laughing matter. India is the world’s largest consumer. Surging gold imports have helped widen the current-account deficit, which was an alarming 5.4% of GDP in the quarter to September (see chart). On January 2nd the finance minister appealed to the nation to buy less gold."

From the Associated Chambers of Commerce and Industry in India this report India's Gold Rush:  It's Impact and Sustainability.   Some of the numbers are staggering.  In terms of consumer demand for gold India stands 50% above the number two country China and miles above any other country.  Data is from the ASSOCHAM report converted to troy ounces (toz).

Gold Demand in toz (1yr ending 2011:III)
	Jewellery	Bar & Coin	Total
India	20,894,285	13,152,565	34,046,850
China	16,361,135	8,384,720	24,745,855
Russia	2,250,500	-	2,250,500
USA	3,835,495	3,028,530	6,864,025
UK	810,180	-	810,180
WORLD	64,885,130	45,305,780	110,190,910

India is the world's second largest country by population so one might expect that in absolute terms they might account for a large percentage of gold demand.  However comparing India to China, Russia, USA, and UK on a per capita basis India still leads the pack with per capita demand for gold nearly 30% greater than the second place country the USA.

Gold Demand Per Capita (1yr ended 2011:III)
	Demand (toz)	Population	Demand Per Capita
India	34,046,850	1,210,193,422	0.028
China	24,745,855	1,354,040,000	0.018
Russia	2,250,500	143,369,806	0.016
USA	6,864,025	315,527,000	0.022
UK	810,180	63,181,775	0.013
WORLD	110,190,910	7,067,000,000	0.016

This result is more dramatic when you normalize by GDP.  Assuming a gold price of USD 1700 per toz.

Gold Demand as a Percentage of GDP
	Gold Demand (USD)		Gold Demand / GDP
		GDP 2012  (USD)
India	57,879,645,000	1,897,608,000,000	3.05%
China	42,067,953,500	7,203,784,000,000	0.58%
Russia	3,825,850,000	1,857,770,000,000	0.21%
USA	11,668,842,500	14,991,300,000,000	0.08%
UK	1,377,306,000	2,429,184,000,000	0.06%
WORLD	187,324,547,000	70,201,920,000,000	0.27%

India's consumer demand for gold as a percentage of GDP is ten times the world average, and nearly forty times that of the US.  However gold is a luxury item so one would actually expect demand share to increase as the country gets richer, so the India case is truly an anomaly.

How did India get to spending nearly 3% of her GDP on gold consumption?
 

Growth of India's Gold Imports
			Imports (assuming $309 / toz)
Year	Imports (USD)	Gold Price per toz
2001-02	4,170,400,000	309.73	4,170,400,000
2002-03	3,844,900,000	363.38	3,277,232,861
2003-04	6,516,900,000	409.72	4,926,485,007
2004-05	10,537,700,000	444.74	7,338,763,819
2005-06	10,830,500,000	603.46	5,558,828,696
2006-07	14,461,900,000	695.39	6,441,398,765
2007-08	16,723,600,000	871.96	5,940,410,831
2008-09	20,725,600,000	972.35	6,601,882,129
2009-10	28,640,100,000	1224.53	7,244,165,658
2010-11	33,875,800,000	1571.52	6,676,562,522

A large part of the problem is that gold prices have increased by a factor of five over the last decade (see here and here).  However even adjusting the price of gold back to 2002 levels of USD 309 per toz India does seem to have increased her import demand over the last decade (imports taken from the ASSOCAM report).

What is the cause of India's ravenous demand for gold?  Per the Economist story  "...the traditional gold consumers are southern peasants buying jewellery. They have no access to formal finance; gold requires no paperwork, incurs no tax and is liquid. But over the past decade the mania has spread. By weight consumption has doubled, for several reasons: a surge in money earned on the black market; investors chasing the gold price; and the dismal returns savers get from deposit accounts. Real interest rates are low, reflecting high inflation and a repressed financial system that is geared to helping the state finance itself."

Is this a bad thing?  Yes it probably is.  A countries productivity is directly proportional to its per capita physical capital stock.  India has a relatively low capital stock per capita.  In many countries household savings are lent to firms either directly through equity purchase or corporate bond purchase or indirectly through bank intermediaries.  Firms use these funds to increase their capital stock and thus the productivity of their workers.  If Indian peasants were to stick their gold in banks and let the banks lend the gold out to firms to buy capital that would be great- but if they instead keep the gold as jewellery or under a mattress then they lose the potential productivity gain.   Anther way to think of it is assume India produces products that are exported  - then it would be desirable for them to use the export earnings to purchase physical capital stock from abroad.  But instead they are importing gold which is then squirreled away under mattresses and does not contribute to increasing the countries capital stock and productivity. 

Doesn't the same argument hold for China though?  China exports goods to the US and in return buys US Treasury bonds.  To some degree yes it is the same argument.  By China holding US Treasuries instead of importing physical capital they are not increasing their capital stock as much as they could and  hence reducing productivity and their future income.  However US Treasuries do have one advantage over gold.  If China holds USD 1 Billion of US Treasuries which expire in 10 years then they know that in 10 years they will be able to purchase USD 1 Billion in goods from the US.  Whereas if they instead owned USD 1 Billion in gold they are at risk that the price of gold falls and they lose purchasing power.  Which do you trust more the USD or gold?   Yes China has an analogous problem but that doesn't mean that India doesn't have a problem.

The ASSOCHAM report (pages 23-24) suggests the following solutions to the problem of India's gold hoarding

1. Increase the reach of banks - India is estimated to have a 30% savings rate of which 10% is being invested in Gold.  However the World Gold Council reports that in rural India only 21% of household have access to formal financial sector - hence the gold purchases.
2. Consider innovative means of alternative investments - apparently it is very difficult to open a bank account in India?  However purchasing gold jewellery is easy.  Perhaps the government could create alternative savings options.
3. Liquidity quotient of alternative investments instruments - in rural areas of India gold is highly liquid while other assets may not be.  Perhaps the government could introduce liquid instruments with a guarantee of buyback.
4. Massive education campaign

Interestingly the history of banking in London dates back to goldsmiths who evolved from artisans to depositories to banking.  See Wikipedia here

"The main developers of banking in London were the goldsmiths, who transformed from simple artisans to becoming depositories of gold and silver holdings. Events such at the appropriation of £200,000 of private money by King Charles I from the royal mint, in 1640 caused merchants to lose trust in the existing institutions and drive them to find more trusted alternatives such as the goldsmiths...Goldsmiths soon found themselves with money they had no immediate use for, and they began to lend it out at interest to merchants and the government. Finding substantial profit in this business, they began to solicit deposits and pay interest on them. The goldsmiths eventually discovered that the deposit receipts they provided were passing from person to person in lieu of payment in coin. This prompted them to begin lending paper receipts rather than coins. By promoting acceptance of the receipts as a means of payment, the goldsmiths discovered they could lend more than the gold and silver coin they had on hand, a practice that became known as fractional-reserve banking.[187]"

Also see here.

One wonders if the Indian government could establish a network of gold depositories which would effectively act as banks.  Peasants could deposit their gold in the depository.  The depository would then lend out a portion of the gold to firms who could use the funds to purchase capital.  The Indian government could promise to insure the gold deposits much like our banking deposit insurance.