Thursday, January 5, 2012

The Commodity Story Update: Bull Horns or Bear Tracks

Commodities are used in the production of economic activity around the world, so a review of the markets that are sensitive to commodities helps to monitor the condition of important pieces in the global economy. Federal Reserve policy can influence prices of commodities, such as the price inflation observed in 2011, created by excess liquidity (monetary policy) finding value in commodities.

It's obvious that China has used their tremendous industrial and manufacturing capacity to increase employment and sustain the mandated GDP target of the government. The following comment, "Growth in China, the biggest user of everything from copper to cotton to coal, will slow to 8.5 percent this year, from 9.2 percent in 2011, the mean of 14 estimates shows" comes from a Bloomberg article discussing commodities. China is the largest customer of Australia, Brazil and other economies, including neighbor South Korea. The economy of South Korea provides an indirect window to their primary trade partner, China. The Kospi is a South Korean stock exchange and coincident proxy of economic change in China. It appears that the Kospi was hit hard in the beginning of August when Greece's debt default, and associated threat to the European banking system, became a reality. Prior to and since then, the trend has been slightly positive change.

Charts courtesy of

Commodity markets are generally priced in US dollars. The dollar strengthened in September, hurting buyers of commodities, a condition that repeated in November and December. If the dollar is strengthening, then commodities will become more expensive and that will be inflationary on prices of goods and services. A sideways trend would provide some unexpected currency stability. A weaker dollar would be welcome relief for commodity buyers and relieve concerns about inflation, as well as supporting prices of many stocks and precious metals. The 10 week moving average (gold line) illustrates a strengthening in the trend. The Fed FOMC is not likely to allow a sustained strengthening move in the dollar index without intervening. What if they do allow it? That will signal risk-off and a move to perceived safety.

News from China is that they have raised interest rates on bank loans and are requiring higher reserves on banks to slow their internal economic growth and real estate development. The sluggish growth of the global economy outside of China is no longer supporting the export based economy it enjoyed internally and the real estate (bubble) inflation that came with it. At the same time, a growing segment of the population still want to raise their standard of living and work for a better wage than they might earn in their villages. China's leaders cannot let the economy slow into a recession without looking bad and risking civil revolt.

The next graph illustrates the Shanghai index, one of several stock exchanges in China. The level in October 2011 was on support last seen in the summer of 2010. Holding this level would have been a positive for global markets. This graph leads to the assumption that pressure is building on the government in China to change this trend.

Next, several commodity graphs and stock markets that reflect equity prices in some commodity rich markets.

Since April 2011, the CRB index has been in a bear market.

The West Texas Intermediate Crude index is remaining close to the long-term trend.

The Brent Crude index has remained elevated compared to historical prices. The trend may also be contributing to sluggish global economic activity.

Next, consider the price of Copper.

Consider Emerging Market shares.

 Consider the Australian All Ordinaries shares.

 Consider the Toronto shares.

 Consider the Brazil Bovespa shares.

It appears that there is a persistant layer of support for commodities preventing a widespread breakdown. Emerging market economies are in the same condition. Not a lot of assets look good and trends are weaker, except the US dollar and oil. Europe is the linchpin for the worlds markets at the present time. The Bloomberg article referenced earlier had this to say about Europe, "Commodities tumbled since April as Europe’s debt crisis widened. Yields on two-year Greek debt surged to 152 percent last month, compared with 0.29 percent for Treasuries of a similar maturity, and the euro weakened 12 percent against the dollar since the start of May. The region accounts for 19 percent of global copper demand and consumes about one in six barrels of the world’s oil." Commodity prices are not as concerning to euroland as the stability of the large banks is. They have taken the concept of fractional reserve banking to new heights. The risk from this practice is now clear. Expect loose monetary policy, tough talk and loose enforcement all leading to more countries being managed and financed by the large banks.

In addition to Fed intervention in the US, there will be more Fed intervention (monetary support) in the Euro as a defense of US banks that are exposed to the major European banks. That job will get done! The FOMC will get new members in 2012. Each January there is turnover of at least four of the eleven seats on the FOMC. The committee will hold it's first 2012 meeting during January 24-25. Anticipating that the three new committee members will be more supportive of balance sheet expansion, Bernanke may be comfortable hinting to a close circle of friends about the committee's QE intention in 2012. It won't take a strong hint to see price support and dollar weakness on signs of new Fed intervention.