China’s Cool Cranks Up Commodities

12/14/2010 3:08 pm EST


Jim Trippon

Editor-in-Chief, China Stock Digest

Beijing’s surprise refusal to hike rates in the face of higher inflation stirred a global rally, hinting at next year’s likely winners, writes James Trippon of China Stock Digest.

China kicked off the pre-Christmas week with an unexpected bang. Rather than raise interest rates again, Beijing held its fire. Although reserve ratios at several banks were tightened, that didn't stop the party.

US pundits missed the mark again. Most of them had been predicting a stiff interest rate hike by China to control inflation. I hope you ignored them.

As we expected, China did come out with new inflation figures over the weekend. The consumer price index (CPI) rose to 5.1% in November. That's a 28-month high. The Producer Price Index (PPI) also continued to climb.

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This was exactly the pattern that most pundits said China would react to with a hike in interest rates. The effect of that could be a slowdown in the Chinese economy, dragging down worldwide growth.

Relief in Shanghai
But Beijing did not hit the panic button. The long-awaited interest rate hike never materialized. Instead, the Shanghai Composite Index celebrated the absence of a rate rise with a 2.9% gain, the biggest jump since mid-October.

The rest of the world followed China's lead. In New York, the S&P 500 reached another high for the year.

But it wasn't a market-wide sweep. The equities that rose provide a good guide to the investments that will continue to gain with China's growth.

Leading the way were the basic materials stocks, including those producing oil, gold, silver and copper. Clearly, China is driving commodities, and companies that produce commodities, worldwide.

Among the other strong performers for the day were companies that make a good portion of their profits selling into China. Caterpillar (NYSE: CAT) is an obvious standout in the industrial goods segment.

Beijing produced more encouraging news over the weekend. Chinese industrial-output growth accelerated to 13.3% last month from a year earlier. Urban fixed-asset investment also picked up its pace, rising 24.9% during the first 11 months of 2010. And all-important retail sales gained 18.7% in November.

Gold rebounded from its biggest weekly loss in a month following China's interest rate decision. Silver and palladium also climbed.

Palladium futures for March delivery gained 3.1% to $755.10 an ounce. Platinum futures for January delivery rose 1.4% to $1,698.30 an ounce. Silver futures for March delivery rose 3.1% to $29.485 an ounce.

Goldman Sachs predicted that gold will climb to $1,690 an ounce next year and peak in 2012. Goldman says a rise in US interest rates beginning next year will eventually end gold's multi-year bull run.

Red Metal Rising
Copper has a much longer secure horizon thanks to China. On Monday, copper rose to an all-time high of $9,235.25 a metric ton on the London Metal Exchange. (Aluminum, lead, nickel, tin, and zinc also gained following China's announcement.)

China is on track to triple its annual use of copper to 20 million tons by 2025. That's according to CRU, a London-based consultancy. In fact, China already tripled its copper consumption over the past decade, reaching 6.8 million tons.

But Chinese copper consumption still remains low compared to the US and Japan. Copper consumption was just 3.9 kilograms per person in China last year, despite the nation's massive building boom. That compares to consumption of 6.5 kilograms per person in the US and 8.6 kilograms in Japan.

Standard Chartered estimates that China's consumption will rise to 5 kg per person by 2015. Doing the math, that's 6.5 billion kilograms.

Perhaps the most telling comment about copper comes from Ben Simpendorfer of the Royal Bank of Scotland. Looking at China's accelerating copper use he told Bloomberg that China can't continue to increase consumption at the current rate, "because there aren't enough mines."

If the prediction is right, we're headed for a period of "peak copper," denoting a ceiling on global production.

[If the commodity demand forecast is even half as bullish as the author suggests, the emerging-markets miners ETF recently recommended by Benjamin Shepherd should do very well—Editor.]

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