The Powerhouse Nation Behind A Volatile Commodities Market
by Tony Daltorio, Investment U Research
Tuesday, May 25, 2010
China has remained the driving force in the commodities market for the past year.
Rising demand from that neck of the woods has driven prices higher and higher... Or at least, it has until now.
Lately, China has given the commodities market obvious jitters. Investors need look no further than the Thomson Reuters/Jeffries CRB index for proof of that. On May 18th, Barron's even referred to the reversal as "the crash you didn't hear."
The index dropped 2% on May 17th to hit a seven-month low. And just the month before, it lost nearly 10%. Copper, oil, corn: It all went down.
Europe's problems certainly haven't helped either. But China is still motivating the market the most right now.
Many investors look at Beijing's efforts to reign in its economy and red-hot property sector. And they instantly see red... especially since it seems to be succeeding.
China's Real Estate Market
Property prices are falling very quickly in China's tier one cities. On average, Shanghai, Beijing and Shenzhen all fell over 20% week-on-week the beginning of the month. And tier two cities like Wuhan and Dalian saw transactions fall by about 18%.
Yet May normally marks the peak sales period of the year.
Still, fears could be overdone. Admittedly, property numbers look bad at first glance. But they're still 6% higher year-on-year in the first week of May. And sales themselves remain strong.
In short, China's housing market remains fundamentally healthy. Demand comes from multi-family, owner-occupied buying fueled largely by cash, not debt.
More than likely, Beijing will mete out the pain to property developers over the next six months or so. But as it sees slower economic growth in the fourth quarter, expect it to start lifting its curbs again.
When that happens, property sales volumes will head back up.
China's Economy vs. Commodity Prices
Chinese economic policy measures may not affect commodity prices as much as many fear.
Beijing's measures differ little from its previous policies over the past 10 years. After all, it has tightened economic control before when it felt the situation called for it. And yet, even with those measures, Chinese demand for commodities has only increased.
Even the recent sharp drop in prices doesn't look as frightening when put in context.
For example, iron ore prices have fallen about 12% since late April. Yet it has gained 32% since January and a staggering 140% over the last year.
Iron ore and many other commodities have enjoyed similar runs, thanks to more than just demand. Supplies of some basic materials, including iron ore and copper, remain tight.
In fact, Glencore - the world's largest commodities trader - told bondholders last week that the "global economy continues to exhibit signs of underlying improvement."
Commodities investors should also remember that China might still resort to other measures. With full support from the United States, it could combat rising inflation by allowing its currency to appreciate. And because that makes imports relatively cheaper, it could possibly stoke demand even further.
Some Chinese commodities traders are now struggling to finance the inventories they've built up. And they may have to scale down their stockpiles, even selling some of their positions.
In addition, Chinese investors have significant positions in commodities futures, especially base metals at the Shanghai Futures Exchange. Selling by these investors would put additional downward pressure on base metal prices.
Playing Commodity Volatility
Investors should position themselves to take advantage of the increased volatility.
For one, BHP Billiton ADR (NYSE: BHP) would be a solid choice. The company operates in major sectors, including iron ore, coal, base metals and petroleum.
Covering even more ground is the very broad-based commodities ETF from Elements, which is linked to the Rogers International Commodities Index, (NYSE: RJI). Put together by famed international and commodities investor Jim Rogers, it includes all of the major commodities. And it also holds positions in more obscure ones such as rubber, tin, rice, wool and canola.
One way or the other, keep in mind that China - regardless of any slowdown - is likely to remain a powerfully bullish factor for commodities for some time to come.