Wednesday, August 27, 2008

Commodities and post-Olympics China

Monday's notes regarding Jim Rogers' views on oil and commodity prices left us with a few questions about the state of the long-running commodity bull market.

Here's how we left off Monday's post:

"Did the recent, sharp summer correction in oil and resource prices mark the end of the 2000s commodity boom, or will the drop seen in leading commodity indexes such as the GSCI and CRB turn out to be a cyclical down move in a continuing, long-term bull market?"

Today we're going to try and answer some of these questions, while also looking at the prospects for China's post-Olympics economy, since China's growth has played such a large role in fueling the rise in commodity prices this decade.

First off, how is China's economy doing and what is the overall economic effect for a country hosting the Olympics?

Historically, economic benefits to host countries have been small, and most observers would regard the national financial impact of an Olympics hosting as rather inconsequential. Despite spending over $40 billion on the Olympics, five times what was spent on the Sydney Olympics, economists feel the effort will have little economic impact on China as a whole, although benefits may have accrued to Beijing as an outgrowth of the city's construction boom.

In fact, with the Olympics now over, China's officials are focused on how to avoid an economic slowdown. Reuters reports that the country's policy makers are trying to goose economic activity by encouraging an increase in power generation, relaxing caps on bank lending, and creating tax breaks for textile goods exporters.

Excerpt from, "After the Games, China's economy faces big hurdle":

"Post-Olympics China is slowing, not because the Olympics are over, but because of global forces," said Don Straszheim, vice-chairman of Roth Capital in Los Angeles.

"China's macro statistics are going to look terrible the rest of this year and into 2009. China wants to act, and supporting the growth rate is going to be overwhelmingly the top policy priority," Straszheim said in a note to clients.

JPMorgan Chase told clients that the government was studying a fiscal stimulus package worth 200-400 billion yuan ($29-59 billion).

A burst of public works spending would reduce China's reliance on exports -- a source of friction with its trading partners -- and address China's fundamental needs. "

So now that the Olympics are over and done with, it seems China will look to fiscal stimulus packages and activity related to infrastructure spending to keep their economy going at the desired rate of growth (hmm, sounds a bit like the US economy).

While we are currently experiencing worries over a possible global slowdown, it's entirely possible that demand for commodities and raw materials (such as oil, base metals, cement) could pick up again in the not-too-distant future as these infrastructure projects gain steam and China's urbanization continues.

Interestingly, commodities experienced a sharp summertime correction around the same time that China was reaching the end of its frenzied economic activity in the runup to the Olympic games. This post-Olympics correction scenario was the subject of much talk in the months and years before the event, but now that such an event has transpired, we have to ask: is it all down to a slowdown China and the emerging markets or are there other forces at work here?

Actually, much of the break in commodity prices could also be explained by events taking place in the financial markets. Given the recent overwhelming investment demand for commodities and commodity related investments, the long-commodities trade may have simply become too overcrowded, which set the stage for a violent shakeout.

Hedge funds began selling their long positions in commodities as the long commodities/short financials trade started to unravel a bit in July. Meanwhile, the recent dollar rally further tarnished commodities' inflation-hedge appeal, which also helped to push commodity prices down during this summer.

Monetary conditions have also played a part in the commodities correction, as Gary Dorsch has recently detailed. In, "Is the 'Commodity Super Cycle' Dead or Alive?", he notes that tightening of monetary conditions by a coalition of six central banks has coincided with the plunge in commodity prices.

"While the Fed, the British, and Canadian central bankers were stoking the mania in the commodities markets, a coalition of six influential central banks, from Brazil, China, Europe, India, Korea, and Russia, were working collectively in the opposite direction.

The Group-of-Six, led by ECB chief Jean Claude Trichet, tightened their monetary policies, in the hope of derailing the powerful “Commodity Super Cycle,” which was wrecking havoc across the global economic landscape."

Dorsch goes on to note that tightening by the central banks resulted in a drop in the Dow Jones Commodity Index in local currencies, and an accompanying drop in the national stock markets, in the case of China and Brazil.

So what's ahead for commodity prices in 2009 and beyond? Nobody knows for certain, but we can try and draw some insights from knowledgeable sources. To that end, I have compiled a short list of extra articles and interviews on this subject for you to peruse.

Related articles:

1. Investors debate extent of commodities rout - Bloomberg.

2. Hedge fund manager Renee Haugerud on oil, commodities - Bloomberg.

3. Commodity correction: an important bottom? - Frank Barbera/FSO.

4. Bill Powers and Jim Puplava discuss energy and commodity prices during the first hour segment (at 34 minute mark) of the August 16, 2008 Financial Sense Newshour broadcast.

See also, third hour "Big Picture" segment of the August 16, 2008 broadcast.

5. Mark Mobius discusses emerging market shares and commodity prices with Bloomberg's Charles Stein (audio).