The blog first learnt about the network effect in the late 1990s, during the successful launch of the eBusiness platforms CheMatch and then ChemConnect. Its Silicon Valley colleagues patiently explained that markets tended to move in predictable stages, once a new concept or product was launched:
- Everyone would initially jump on the bandwagon, not wanting to miss out on the potential for the new innovation
- A rising tide would then ‘lift all boats’, and the entire market would take off very strongly
- But then customers would become more selective, as they better understood the various value propositions
- Some offerings would then start to disappear from the market, leaving just a few to compete
- In time, one ‘winner’ would emerge, as the network effect encouraged a focus on the leading company
- In turn, this ‘winner’ would then have to compete with existing companies in the non dot-com world
This forecast proved entirely accurate as the dot-com market matured. CheMatch was bought by ChemConnect, which in turn ended up as part of the highly successful InterContinental Exchange. It then made the transition to global market leader due to its superior value proposition. Thus it now owns a global network of exchanges including the New York Stock Exchange.
We can now see the same principle applying in financial and commodity markets, since the launch of the central banks’ liquidity programmes in March 2009. Initially these led to a broadly-based rise across the world. But by April 2011, this effect was clearly waning, leading the blog to launch its Downturn Alert series. As the chart shows:
- Very few of the benchmark’s chemical products have since moved above their price on 29 April 2011
- This highlights how the problems of the real world are not being solved by the electronic printing of banknotes
- China’s PTA market was briefly higher in September 2011, but is now much lower despite rally attempts (red line)
- US polyethylene never rallied, highlighting the lack of demand that questions current expansion plans (brown)
- Fictitious supply concerns have failed to boost Brent oil, which is now moving within just a $5/bbl range (blue)
- Naphtha has been weakened by slowing gasoline demand as the ageing populations drives less, and cars become more fuel-efficient (black)
Only benzene (green) has seen higher prices, due to the supply shortages caused by its by-product status. But now even its price has fallen back, and the seasonally lower demand period of H2 stretches ahead.
Thus the network effect is now singling out financial assets for the final melt-up rally, as the blog discussed last week. Already Japan has begun to disappoint, with the yen stabilising over the past year (orange). Only the US S&P 500 marches boldly on (purple).
No wonder, therefore, that the European Central Bank now feels under pressure to tackle the problem it thought it had avoided – deflation. But as the blog will discuss tomorrow, its efforts are doomed to fail, as they continue to ignore the wisdom of Einstein that “a good definition of lunacy is to repeat the same action, and expect different results“.
The network effect is now playing out, just as in the eBusiness world of the 1990s, with one crucial difference:
- The InterContinental Exchange became the dominant player because its electronic model worked better for the existing exchanges, as well as for the new online marketplaces
- The cental banks don’t have this inherent advantage. 50 years of increasingly life expectancy and falling fertility rates, combined with a stable pension age, means only major political change can prevent the West entering a world of deflation
Investors will therefore come to recognise in due course that the central banks’ efforts only made matters worse, not better, by creating a mountain of debt which could never be repaid.
The blog’s weekly round-up of Benchmark price movements since January 2014 is below, with ICIS pricing comments:
PTA China, down 10%. “Despite the limited availability, buying interest during the week remained largely stable, with purchases done on a need-to basis”
Benzene, Europe, down 2%. “Prices dropped to a yearly low this week, with some downstream production output issues plus a long expected downward correction in the market making themselves felt”
US$: yen, down 3%
Brent crude oil, flat
S&P 500 stock market index, up 5%
Naphtha Europe, up 3%. “Poor sentiment in Asia has negatively affected Europe, while domestic petrochemical demand remains muted”
HDPE US export, up 7%. “Demand is still weak, particularly in South America”