Rudi On Thursday

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(This story was originally published on Wednesday, 17 August 2009. It has now been re-published to make it available to non-paying members at FNArena and readers elsewhere).

This week’s data releases in China carry more importance than they appear to at face value. Mainstream financial media report China released another batch of robust economic indicators, suggesting a continuation of the “China will save us all”-theme that has thus far dominated commentary and investment strategies in the first eight months of this year.

Contrary to these reports however, this week’s data releases might signal the exact opposite is about to happen: investors could come to realise they have as per usual driven the fast and furious recovery theme a few bits too far. That’s why this week’s data could turn out to be pivotal: they could serve as the first real indications.

This week’s Chinese data were robust, no debate about that, but market expectations prior to the releases were higher. This matters in that even the bulls seem to acknowledge that commodity markets have become a little frothy. Note, for instance, that Baltic freight rates have been in a downtrend for weeks, yet prices for crude oil and base metals have largely ignored this indicator. Commodity analysts at ANZ pointed out yesterday the Baltix Dry Index (BDI) has just posted its worst weekly performance since October last year.

This is why this week’s data releases in China could prove important: they are a reminder that markets tend to run too far, and that the same applies to forecasts and expectations by economists and analysts. First they run too far to the downside, then they do the same to the upside. Earlier in the year, when it was yet to be determined what kind of growth rate the Chinese would reveal to the rest of the world, experts seemed in a contest to predict the lowest figure. At least one hedge fund expert went as far as to predict a negative outcome – for the whole of 2009!

Since the release of the official first and second quarter GDP growth estimates, however, the market has swung to the other side, with lots of experts now anticipating it won’t be long before we will see double digit GDP data again – or at least 9%-plus. This reversal in overall mood has supported increased money flows into commodities over the past weeks and months.

Commentators and journalists across the world may put in a lot of effort and research in trying to link market movements to data releases and fundamental market indicators, but what is often forgotten is that money flows do not necessarily reflect the here and now. However, these money flows do impact on prices nevertheless (especially when they involve large fund managers).

This is partly why international freight indicators can have a bad hair day, or even a bad hair week, or more, and yet money continues to flow into markets, and prices continue moving up.

This week’s Chinese data have put many analysts and economists around the world on notice that their upwardly revised projections may well be a bit too rosy. This does not immediately spell Armageddon for the sector. Contrary to when expectations turn out too low, when they seem a bit high forecasters tend not to immediately reduce them, especially not when they have just been revised higher. So it is far more likely that any downward corrections will require more time. Mind you, it is not yet a fait accompli that reductions will become necessary.

The Big Question for investors is, of course, what does this mean for commodity prices? What can we expect? What should one do?

I won’t beat around the bush: I firmly believe commodities are in a mini-bubble. Not in a big one, but in a bubble nevertheless. Some critics look at present share market valuations and argue forward looking Price-Earnings Ratios of 13 (on FY11 estimates) are a bit pricey. I agree. But this doesn’t imply the sky is about to come tumbling down. There is still room to appreciate further, especially if underlying expectations rise a little more.

Similarly, I believe crude oil futures above US$70/bbl are a bit of a joke, really. Should aluminium really be trading near US$2000 a tonne and nickel close to US$20,000 a tonne? I doubt it.

But here’s the catch: as long as there is sufficient support from economic data and from money flows looking for the best destination, I am not anticipating any grave corrections in the foreseeable future. Pull-backs will occur, but they are likely to prove merely dips in a continued uptrend.

This view is based upon my expectation that economic data and developments are likely to continue surprising more to the upside than to the downside, for now, plus the fact that a lot of cash is still waiting to be deployed, looking for a destination that will yield a return. Easy monetary policies always translate into inflated asset prices.

In China this has led to the creation of a new army of commodity speculators. While the country’s unsustainable level of imports has led to today’s mini-bubble, I’d like to draw a comparison with investors in property markets: unless property owners are forced to sell, they tend to hold on to their assets when market pricing is too low. I think the owners of excess inventories in China will do the same.

In addition, I am keeping a close eye on what is happening with the US dollar. There remains the possibility that, at a time of flattening economic data, unexpected support might well come from another bout of US dollar weakness.

The problem with these bubbles is that one can worry too much, too early and the result might subsequently be that one sells out too early and is then forced to agonise from the sidelines while everyone else seems to be having a good time. Of course, all this is dependent on what investment horizon we’re talking about, at what prices we bought in, etcetera.

Every time I look at BHP Billiton ((BHP)) shares I see a stock that is trading at 17 times projected earnings in FY11. All this tells me is that I shouldn’t be chasing it. What it doesn’t tell me is whether tomorrow will see another rise or a pull-back. As a matter of fact, BHP Billiton shares rose a little further today.

With these thoughts I leave you all this week.

Till next week!

Your editor,

Rudi Filapek-Vandyck
(as always firmly supported by Greg, Chris, George, Pat, Rob and Andrew)

P.S. I – the main question that has yet to be answered in the weeks and months ahead is how much a slowing in Chinese lending will impact on the country’s imports of raw materials. To put the enormity of the Chinese stimulus in perspective: one expert recently stated on financial television that total loans pumped into the economy by Chinese banks so far this year nearly equalled the size of the Indian economy. It goes without saying this has been an unprecedented exercise, and this simply cannot be sustained. This leaves us with the open question of how much commodity markets will be impacted from reduced Chinese stimulus.

BTIG Chief Market Strategist Mike O’Rourke summarised the question into three charts this week (see below). What we have yet to find out is what the fall in the first chart (China new loans) will mean for the other two charts (China Crude Imports and China Iron Ore Imports).

 

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