China's Impact on Commodities

02/18/2010 12:00 pm EST

Focus: COMMODITIES

Eric Roseman

Editor, The Commodity Trend Alert

Eric Roseman, editor of Commodity Trend Alert, discusses the role of the Chinese government’s tightening policies on commodities prices and the US dollar.

For the second time in as many months, China has tightened credit. News of a second wave of tightening drove commodities prices sharply lower as fears grow that demand for raw materials will ebb. Despite the bearish news, commodities remain up slightly in February.

China [has been] the single largest source of commodities demand over the last ten years as her booming economy devours everything from crude oil to base metals. According to Goldman Sachs, Chinese demand accounts for 41% of the world total for cotton, 36% for lead, 33% for aluminum, and 23% for soybeans. It’s also responsible for 9% of global oil demand.

But fears of an asset bubble in real estate have drawn the authorities into action following an avalanche of lending the first four weeks of 2010. China is overheating, and nowhere is that more obvious that in bank lending and money-supply growth.

No other commodity is more sensitive to the Chinese growth cycle than copper. Prices must stay above their 200-day moving average in this correction or risk a bigger fallout, which would smash the industrial metals and other commodities.

So far this month, we’re seeing some solid gains in the gold stocks as they begin to recover amid an oversold euro-dollar cross rate.

I expect the euro, which is now in a bear market because of a credit crisis attacking Greece and other weaker fiscal members, to post a sharp short-term rally before going down again. What this implies is that the dollar will correct from these levels against the euro and in all likelihood, pull back against gold.

Still, even as the dollar has surged this year, gold prices are almost unchanged. That’s pretty impressive price action considering the strong move in the dollar.

The dollar is overbought. Technically, the currency looks bullish as it breaks out of recent bear market ranges since late November. But if we were oversold heading into November, then we’re now verbought in mid-February.

The markets have priced in a tightening by the Federal Reserve later this year—probably too aggressive considering the state of government credit markets in Europe and China’s rising tightening concerns. I’m not convinced the Fed has to tighten in 2010—especially if markets begin to tank again.

The gold stocks have been hit hard over the last few months, but are now oversold. We saw some constructive price action [recently], and a weaker dollar should help boost prices. Gold [recently] pierced $1,100 for the first time since December. I remain bullish on the complex and advise investors to accumulate high-quality gold stocks and silver shares.

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