CHINESE INFLATION DRIVING GLOBAL COMMODITIES HIGHER -- ASIAN DEFLATION HAS CHANGED TO GLOBAL REFLATION
BUYING INDUSTRIAL METALS... A big reason why commodity markets have been rallying so much this year is the result of buying by China. Investors Business Daily's commodity page this morning carried the headline "Soybeans Soar on Chinese Buying". Soybeans are trading at the highest level in six years. China has also been blamed for multi-year highs in cotton, copper, and livestock markets. The Chinese have a lot of people to feed. And their huge manufacturing economy needs raw materials. As a result, the CRB Index is within a couple of points of hitting a new six-year high. Back on October 9, I showed a chart of industrial metals breaking a six-year down trendline. Chart 1 is a more recent version of that chart. I suggested at the time that the higher trend of industrial metals (aluminum, copper, lead, nickel, tin, steel, etc.) was reflecting the change from deflationary trends starting in Asia in 1997 to a more reflationary trend during 2003. I also made the point that Asia was leading the trend from deflation to reflation. A Wall Street Journal article this morning entitled "Inflation Returns to China" makes the exact same point. It points out that this year marks the first sign of inflation in China since the Asian currency crisis in 1997 pushed Asian prices lower. The article goes on to claim that signs of inflation in China (although small) are a good sign that the global deflationary trend that started six years ago has ended.
Chart 1
COMMODITY GROUP RELATIVE STRENGTH... Since the start of 2003, the CRB Index has risen 6%. Four of the five commodity groups shown below have actually outperformed the CRB. That shows that the commodity rally is pretty broad-based and not just limited to one or two groups. The only commodity group to lose ground this year is energy, which has lost 3%. The five charts shown below are ratios of each commodity divided by the CRB Index. They're also shown in order of relative strength for this year. The top performer is Industrial Metals (+21%). Agricultural commodities (mainly grains) gained 12% and have only just started to show relative strength. Precious Metals (+10%) have been commodity leaders over the past year, but have started to show some relative weakness. Livestock markets gained 9% during the year, and are also starting to slip a bit. Energy markets have been underachievers all year. The fact that Industrial Metals are leading -- while energy is lagging -- is a good sign for the global economy. Sector-wise, it also explains why basic material stocks have been doing so well this year, while energy stocks have been lagging. Rising commodity prices are usually associated with rising interest rates, which is bearish for bonds. Rising commodity prices are also associated with a weaker dollar. Asian deflation starting in 1997 pushed commodity prices and interest rates lower. Asian relation in 2003 is having the opposite effect. The trend toward reflation suggests that stocks will continue to outperform bonds.
Chart 2
Chart 3
Chart 4
Chart 5
CRB INDEX TESTING OLD HIGH... The CRB Index is testing the highs reached just before the Iraq war during February. That's a very important test. A close over those highs would put the index of commodity prices at the highest level in six years. Yesterday's Fed announcement that it plans to keep short-term interest rates down is bullish for commodities. Efforts being put on Asian countries to let their currencies rise is bearish for the dollar, which is also bullish for commodities.
Chart 7
