Higher commodity prices are China’s fault
Posted on 07 December 2010
That is the view of Larry Meyer, former Fed Governor, now simply ‘well connected’.
In this interview, with David Einhorn as the foil, he couldn’t be clearer…commodity prices are being bid up by the ‘booming’ economies of China and Asia that have mistakenly adopted US monetary policy. That higher commodity prices may actually reduce disposable income in the US, he doesn’t refute. The implication is that it is China that is causing the problem, not us.
The politics of global diplomacy aside, that China is struggling under the weight of US liquidity is becoming pretty clear. Inflation has popped. The party machine is caught between tightening money to stave off a bout of super charged consumer price inflation and a precariously leveraged real estate sector. The one constant in all the analysis on China is that the party elite will always defer to the policy that will placate the people – higher food prices lead to civil unrest. A bankrupt banking sector is manageable by comparison.
The question then isn’t whether China will slow. It is whether it will be a hard landing or soft one. Either way the chances are that the current disconnect between the Chinese equities market and commodity prices can’t be sustained.
The Europeans may stop sterilising their purchases and get into the debt monetisation game with the US – and perhaps this is what the risk markets are anticipating. But it’s unlikely to happen until we head further into the European crisis. In the meantime, the chances of a correction in commodities are rising. We may have a little further to run – but watch for momentum divergences as a signal to exit longs.
One final thought – We’ve all been trained to buy the dip in the long term commodity super cycle. But there’s a question mark over how the market is already positioned. The financialisation of commodities has taken these markets into uncharted waters – just how will ETF investors behave if fears grow of a hard landing in China. Then we could get a really nasty washout in commodity prices…
3 responses to Higher commodity prices are China’s fault
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[...] On the disconnect between commodities and Chinese equities. (Data Diary) [...]
Rohan,
As you said, “The question then isn’t whether China will slow. It is whether it will be a hard landing or soft one.”, is probably the key to figuring out commodities over the next 12 months or so.
To be fair to the Chinese decision-makers, they have proven fairly adept in engineering soft landings when required (or they at least appear to have been successful based on the stats coming out of China).
What about supply though? We hear so much about demand from China and India and others, but I imagine that supply must be booming as miners rush to take advantage of higher prices. Even allowing for the long lead time of new iron ore or coal mines or whatever, you would think that supply would have increased fairly substantially over the past 2 to 3 years.
Perhaps we’re about to see what happens when reduced demand meets increased supply?
Fair point, though to state the bleeding obvious – something I excel in! – depends on the commodity. Certainly, iron ore supply is about to bloom.
As the experience of the GFC suggests, those take-or-pay contracts aren’t going to help if Chinese demand ain’t there. Couple that with excess capacity in the developed world (some useful insights on steel in Hugh Hendry’s latest letter) and pricing of the majors looks a little rich…but heck, I’ve been saying that for months now. Let me put it another way then – there are better risk/reward trades out there.