Another way of describing the sharp recovery in prices for everything from iron ore to copper over the past 30 days is to see it as a financial markets event which may, or may not, precede a real-economy event.
As the evidence sits today, it would be wise to see what’s happening as a bubble which lacks substance, until proved otherwise.
For some investors sitting on fat profits from trading in commodities or the companies producing them, that warning might ring hollow. After all, they’ll be thinking: “It’s five years since the last peak in commodity prices and surely it’s time for a recovery.”
In normal circumstances that would be a fair view. Commodities are, if nothing else, cyclical.
The problem with that optimistic view is that these are not normal times and while it might be comforting to think that a routine ‘up leg’ of a conventional cycle is underway, nothing could be further from the truth, for four reasons:
• The China driven boom in the first decade of this century really was a once in 250-year event driven by that country’s version of an industrial revolution
• Much of what’s happened in China has been genuine demand but a lot has been debt-fuelled speculation
• China is changing, by government edict, from a construction phase of its evolution to a consumption phase which means the great building boom of a few years ago will not be replicated, and
• China is home to the world’s greatest concentration of gamblers.
Layered on top of those factors are other changes that investors in the western world should not forget, such as China accounting for 50% of certain commodities, including most minerals and metals, and that China now controls the exchanges were those commodities are traded.
""Seasoned observers are looking at the recent surge in mineral prices and wondering whether they’ve missed something in the data, or whether what’s happening is a false recovery driven by speculative traders who have moved well ahead of a genuine recovery"
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Control of exchanges is a situation which did not exist at the start of the Chinese industrial revolution, a time when western institutions such as the London Metal Exchange (LME) played a pivotal role in setting prices.
Today, Chinese institutions control a significant share of metal markets through mainland exchanges such as those in Shanghai, Dalian and Zhengzhou – or through institutions under de-facto Chinese control, including Hong Kong Exchanges and Clearing (HKEX), owner of the LME.
In a way, the transfer of commodity pricing power from the Western world to the East is a natural development given the dominance of Asian (especially Chinese) consumption of the world’s commodities.
But that’s when the question of Chinese market control gets a little murky because while the country can appear to behave as a conventional market-driven economy, nothing, once more, could be further from the truth.
China, despite attempts to portray itself as business, markets and financially friendly remains a communist dictatorship; a place where the government still believes it is possible to control a market through government pronouncements.
If in doubt about that, or in doubt about the dangers to commodity markets from Chinese control of exchanges, consider what happened last year when the government decided that the stock market was over-heated.
Heavy-handed attempts to control the prices through government-funded trading in shares eventually led to a US$5 trillion wipe-out, the effects of which are still be felt today.
It is remarkably easy to see what happened on the stock markets of China being repeated on commodity markets if the government decides that prices have gone high enough and are endangering its attempts to orchestrate a soft landing for an over-heated economy.
Just how over-heated was confirmed by the latest analysis of China’s bulging debts, which have reached a level that led to the start of the credit crunch in the US followed by the global financial crisis; or the Japanese debt binge, which led to decades of low growth.
According to this morning’s Financial Times newspaper China’s total debt levels have reached 237% of gross domestic product thanks to the debt orgy which has driven the country’s building boom and fed the frantic trading of gamblers on stock and commodity markets.
Back in 2007, just before the world plunged into the financial crisis China’s total debts represented 148% of GDP.
Ha Jiming, chief investment strategist at Goldman Sachs, wrote earlier this year (according to the FT) that: “Every major country with a rapid increase in debt has experienced either a financial crisis or a prolonged slowdown in GDP growth”.
And therein lies the ultimate problem for commodity traders and commodity-producing companies – you can’t have stronger real demand and long-lasting price rises without a corresponding increase in genuine demand and consumption.
That’s why seasoned observers are looking at the recent surge in mineral prices and wondering whether they’ve missed something in the data, or whether what’s happening is a false recovery driven by speculative traders who have moved well ahead of a genuine recovery.
Or, as a headline writer for the Bloomberg news service put it so succinctly on Friday: “China’s great ball of money is rushing into commodity futures.”
No prize for guessing that a headline in the not too distant future could read: “China’s great ball of money is rushing out of commodity futures”.
Interesting times, aren’t they!
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