The global economy is now slowing with several countries in Europe and Asia either in recession or at the brink of a contraction in output. But China, the world’s main driver of commodities consumption this decade, continues to grow, suggesting the severe declines witnessed for raw materials since July are way overdone.
Since hitting a peak on July 3, the benchmark Reuters/CRB Index has plunged 25%. All commodities representing this index have declined sharply, including crude oil (32%), gold (22%), copper (22%) and the grains (28%). The chart below, dating back to June, clearly shows an oversold condition based on the MACD that has progressively worsened over the last 60 days.
The “China Factor” applied to commodities demand remains one of the more formidable equations supporting raw materials. As commodities have crashed recently, the Chinese are once again hoarding industrial metals like copper, tin and steel scrap. This demand won’t disappear because of credit problems in the United States – not with USD inflation-adjusted interest rates in negative territory. The U.S. Fed Funds currently stand at 2% versus 5.6% inflation through July.
The Chinese have started to expand credit again after tightening the money-supply since 2006 in small increments. China can’t afford a recession; a major contraction in output would devastate the economy and result in tens of millions of people becoming unemployed. The People’s Bank of China also has the capacity to spend heavily to finance a continued expansion.
As Eric put it in a recent blog post…
“If you think the Federal Reserve has muscle, think again. China is home to more than $1.7 trillion dollars in foreign-exchange reserves. They can literally bail-out the entire American banking system with one check! They’ll do everything they can to keep this expansion going strong.”
In short, commodities, which were heavily overbought heading into 2008, are now heavily oversold.
In Eric’s view, the U.S. government played a big role “talking down” commodities by attacking oil trading speculation. In an election year, it’s really no surprise the Feds are targeting oil prices. They wanted lower oil prices and they got it. But their talk won’t be able to hold down prices forever.
Yes, the global economy is slowing this fall. Europe is several months behind the United States in this credit squeeze and Japan is basically in recession again. But the emerging markets should get a dose of good news as oil and food prices have plunged by about 25% since July.
These countries, including China, will continue to expand even at the expense of weaker exports. China, India and many other emerging markets are piling billions into domestic infrastructure projects. Eric expects these and other domestic projects to keep those markets humming until the West can stabilize credit markets.
