We have an interesting chart for your consideration. Interesting, as in, 'get a load of this and tell me it's not cause for concern'. It's a weekly index of the Reuters/CRB Continuous Commodities Index (CCI).
As you can see, the collapse of the index in 2008 was dramatic. The recovery throughout 2009 was impressive but it began to falter in 2010. And just when it appeared the index might be on the verge of breaking down again in mid-2010, it has taken off in a six-month, near vertical frenzy.
You might recall that mid-2010 was when the realisation dawned that we were not experiencing a standard, post-war recovery. The European sovereign debt crisis was the catalyst for the wake-up call.
Talk of deflation was the dominant theme. This freaked the world's central bankers out. If deflation took hold, their clients, the private bankers, would go under.
So central banks, most notably the Federal Reserve, the ECB, Bank of Japan and People's Bank of China, began to expand their balance sheets…again.
In China's case, credit growth was running at an incredible 30%+ in late 2009. Measures to slow this credit expansion worked pretty well in the first half of 2010 and growth slowed to around 18%.
Since then though, the pace of credit growth has stabilised as China's investment boom continues.
Investors reacted to this by buying anything connected to the word 'risk'. Risk assets are in vogue, such is the faith in central bankers to not let the market fall.
But one look at the chart above should give you cause for concern. There are no absolutes in investing. No one knows what will happen tomorrow, next week or next year.
The best we can do is work with probabilities. What is the probability of commodity prices surging higher from here? We would think low.
The general consensus is that we're on the cusp of an inflationary outbreak and hyperinflation is coming to a town near you. Maybe in a few years, but it's unlikely to transpire now.
The developing world is already overheating as loose global monetary policy wreaks havoc. Developing economies, desperate to maintain their export dependent economic structures, are intent on maintaining competitive exchange rates. Achieving this creates inflationary pressures in their own economies.
This means we are now seeing countries, most notably China, trying to fight inflation.
One way of doing it would be to let their currencies rise. But this is not a politically easy course of action when your economic growth model has been built around export growth.
With a visit to Washington coming up next week, Chinese President Hu Jintao is playing the game nicely. According to a report in today's FT,
'…the People's Bank of China allowed the currency's daily trading reference point to strengthen through the Rmb6.6 per dollar level for the first time on Thursday, a day after Tim Geithner, US Treasury secretary, reiterated concerns about China's currency policy.'
'Yes', he will tell President Obama, 'we are letting the yuan appreciate slowly, but don't push us'. Will he also explain why Chinese foreign exchange reserves climbed another US$200bn in the last quarter of 2010, and now total US$2.85 trillion?
Probably not.
Currency movements and politics go hand in hand. The UK's Telegraph tells us that:
'Herman Van Rompuy, Europe's president, said during a visit to Downing Street that the Chinese may have "political" thoughts in the back of their minds for coming to Europe's help, and gave a strong hint that they are also engaging in currency manipulation.'
Thanks for the newsflash, Herman.
Of course Chinese buying of euro-denominated debt is political. Around a quarter of that US$2.85 trillion hoard is denominated in euros. It's in China's interests to buy up distressed debt, which in turns provides support for the euro.
According to the article, Chinese buying, along with buying from the ECB this week, took the pressure off the Portuguese debt raisings.
How long this game can go on for is anyone's guess. But we think the beneficial effect on global commodity markets has nearly run its course.
To continue rising from here, commodity markets will need greater and greater amounts of liquidity. That will be a hard feat to achieve even for Ben Bernanke and Co.
Whether it turns out to be another big market bust or just a 'correction' of 10–20% is anyone's guess. But for even the most nimble trader, the commodities market looks dangerous from here.
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