Commodity price drop and China's role

China leads commodity price boom -- and bust

Dollar, yuan, currency, puzzle Dollar, yuan, currency, puzzle

Commodities have been sinking like stones since late February, an unusual divergence from the rallying stock markets. This relentless weakness has wreaked havoc on commodities sentiment, leading traders to abandon commodities stocks. As we all try to make sense of this surreal bloodbath, one catalyst keeps coming up. Western perceptions of the Chinese economy have been a real drag on commodities.

China is indeed one of the major drivers of this past decade’s secular commodities bulls. As the world’s most-populous country, it has over 1.3b people who collectively consume vast amounts of resources. China sports the fastest-growing major economy on the planet, which has recently catapulted it to become the world’s second largest after the US. China is also the second-largest importer on Earth.

Many of these imports are raw materials, which China’s myriads of factories fashion into finished goods that are exported globally. As the world’s largest exporter, the sheer quantities of commodities necessary to feed this machine are staggering. And the great income this export trade generates is inexorably raising the standard of living in China, and of course wealthier people consume more commodities per capita.

So there is no doubt China is at the heart of the global commodities boom, this giant’s incredibly rapid rise is unprecedented in world history. Thus Western investors and speculators eagerly hang on every data point that might illuminate how China’s economy is faring. And unfortunately for commodities and the stocks of their producers, recently these reads have been coming in below Western expectations.

The latest arrived heading into Friday April 13th, when China’s National Bureau of Statistics released the country’s Q1 GDP. And though it came in at an awesome annual growth rate of 8.1%, which any other major country would die for, this disappointed traders. Q4’s growth rate was 8.9%, so China was seen to be “slowing”. And coming in below expectations of 8.3%, it was decelerating faster than feared.

So that day futures traders dumped commodities, driving their primary index down 1.2% to challenge a new correction low. Unfortunately there are plenty of instances like this over the past year or so. I could easily write a whole essay explaining them and their immediate market impact. But the key takeaway for now is China slowdown fears are inarguably a major thorn in the side of commodities prices.

As I’ve contemplated this while lamenting the ongoing carnage in commodities stocks, I’ve wondered about the Chinese stock markets. Here in the States, the fortunes of our flagship S&P 500 stock index (SPX) color the sentiment for the entire country. I elaborated on this recently in an essay on the SPX’s impact on the upcoming US elections. With greed and fear universal, why would China be any different?

Are the fortunes of the Chinese stock markets affecting traders’ outlook on that country’s economy both domestically and globally? And if Chinese stocks have been weak, is that a major factor contributing to the odd divergence witnessed in commodities recently? I decided to take a look, and the results are provocative. Indeed US commodities prices have been following China’s stock markets lower lately.

Naturally the mighty SPX is the best measure of US stocks’ progress, and the old-school Continuous Commodity Index (CCI) remains the premier way to track commodities as a group. Over in China, the local equivalent to the SPX is the Shanghai Stock Exchange Composite Index (SSEC). It is based on its components’ total market capitalization relative to a starting day (in December 1990). Like the NASDAQ Composite, the SSEC’s components include all stocks listed on that exchange.

In order to investigate any potential interrelationships between commodities prices and the Chinese stock markets, I built a couple charts comparing the two. To keep their percentage moves perfectly comparable, I indexed each to a common base of 100. For reference, the SPX is also included. And its well-known major highs and lows are used as the base dates from which all three series are indexed.

spx, cci, stocks, commodities

This first chart normalizes the premier commodities, Chinese stock, and American stock indexes from the common base of the SPX’s major interim high at the end of last April. As the SPX started consolidating and then correcting, the SSEC and CCI followed it lower in similar selloffs. Commodities were actually considerably more resilient than both countries’ stocks in tumultuous August, with the CCI surging fast.

Next page: When the woes began

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