The "Commodity Super Cycle" goes into Extra Innings
The "Commodity Super Cycle" went into extra innings last week, when the Reuters Jefferies Commodity (CRB) index rallied to as high as 359.14, eclipsing the previous high of 350.96 set on February 2nd. Rarely do so many economic and political forces all point to one single direction. Fueling the "Commodity Super Cycle" is China's juggernaut economy, which is spreading its wings to Japan, South Korea, and across the Asian region, and creating strong demand for natural resources.
In the background, global central bankers have been expanding their nation's money supply to immunize their equity markets from the effect of soaring energy and raw material costs. And lurking in the background is a US stand-off with Iran's madman Mahmoud Ahmadinejad, who once again, called for the annihilation of Israel on April 15th, disclosed that Tehran is enriching uranium, and has threatened to close the Strait of Hormuz if attacked, making crude oil markets very jittery.
Moving into extra innings "Commodity Super Cycle" means the easy money is already behind the Reuters CRB rally, and going forward, traders would climb a wall of worry, where sudden panic sell-offs come with the territory. Metals dealers know how to shake out weak handed speculators along the way, and the volatility in the metals and energy markets are bound to reach record proportions.
Global hedge funds who control about $1.5 trillion, have been piling into copper, crude oil, gold, silver, platinum, and zinc, the super-stars of the "Commodity Super Cycle" to grab quick profits and driving up prices with no intention of ever taking delivery. Schizophrenic hedge fund traders can roil the markets in the short term, but stronger handed commodity importers in Asia, Europe, the US, and elsewhere, would determine the longevity of the cycle.
Going into extra innings means there is less room for error, where periodic shakeouts seem designed to scare off first time buyers. The "Commodity Super Cycle" is expected to take the fewest number of passengers along for the ride. But as long as global equity markets remain buoyant and G-7 central bankers refuse to tighten their money supply in a meaningful way, the "Commodity Super Cycle" will remain a major force to be reckoned with in the foreseeable future.
And everything depends upon proper listening. If ten people listen to the same speech or story, each one may understand it differently. Perhaps only one of them will understand it correctly. Therefore, listen to the riddles of the G-7 central bankers with a healthy dose of cynicism, brush away their smokescreens designed to cloud your vision, in order to profit in the global commodity and equity markets.
From a purely technical perspective, the Reuters CRB index tested key horizontal support at the 315-level in early March, following a nasty 8% correction in February. The CRB index received good support from a major upward sloping trend-line that coincided with the 315-level, where the index built a solid base of support, before catapulting higher into extra innings.
"A trend in motion will stay in motion until some outside force knocks it off its course." So until the CRB index falls below the key horizontal support at the 315-level, the technical outlook remains bullish. In times of doubt over the long-term longevity of the "Commodity Super Cycle", it helps to review the fundamental forces that brought it here, and the bumps it has endured along the way.
The Commodity Super Cycle's four year journey to 25-year highs begins with China, which moved past France and the UK to become the world's fourth-largest economy in 2005. China is leading the world in demand for raw materials to power its booming industrial sector, presenting strong demand for crude oil, iron ore, coal, copper, nickel and zinc, the premier leaders of the "Commodity Super Cycle."
China's economic output grew by a powerful 10.2% in the first quarter of 2006 from a year earlier to $2.26 trillion. China's trade surplus widened to $11.2 billion in March, the second-highest on record, as its exports jumped 28.3% from a year earlier to a record $78.1 billion, and its imports rose 21.1% to $66.9 billion.
Beijing expanded its M2 money supply by 18.8% in March from a year ago, and is flooding local bank's with massive liquidity. Chinese banks arranged 1.26 trillion yuan of new loans in the first quarter, up 70 % from a year earlier. Yuan deposits held by local banks still exceeded yuan loans by 9.67 trillion yuan at the end of February, equivalent to 48% of yuan loans. The liquidity ratio was just 9% in 1997.
China's economy is overheating, but so far, the People's Bank of China hasn't taken any action to control its exploding M2 money supply. Last week, the PBoC injected a massive 103 billion yuan into the banking system, leading to speculation that the central bank is still aiming for maximum economic growth with a cheap yuan policy. The PBoC hasn't taken any measures to lift local interest rates for 18-months.
Surging Chinese credit growth, a widening trade surplus and double-digit economic expansion, is lending support to explosive Chinese demand for minerals from abroad. China is the world's largest customer for copper, and its demand grew 9% last year, consuming 22% of the world's supply. China became a net importer of zinc for the first time in 2005, when it imported 620,816 tons of zinc, equal to about 6% of world demand, as its steel production jumped 25 percent. Both metals have gone parabolic, with Beijing caught in a supply squeeze.
Copper stockpiles at the London Metals Exchange have dwindled to 118,000 tons, or less than three days of global consumption. Zinc inventory has plummeted 32% so far this year to 267,250 tons, less than 10 days of global demand. US light crude oil has surged 23% this year to record highs of more than $75 per barrel, even though US oil stockpiles are hovering at 8-year highs. Despite the surge to $75 per barrel on April 21st, oil prices are below their inflation adjusted price of $87 per barrel.
China's central bank prints yuan in exchange for foreign currency obtained from foreign trade, foreign direct investment, and speculative hot money, and amassed a treasure chest of $875.1 billion of foreign currency reserves in March. Gold dealers expect Beijing to eventually swap depreciating US bonds into gold. Beijing holds 19 million ounces of gold, which only represents 1.1% of its reserves.
When asked about a possible shift from the US dollar, People's Bank of China chief Zhou Xiaochuan said on April 22nd, "I think China is among the best in managing our foreign exchange reserves. We get good returns in safe, liquid assets. We can adjust very quickly." But gold is up 45% while 10-year US Treasury notes have lost 3.2% in the past year, and according to the latest data, Beijing has not yet moved!
Japan's economy, the world's second largest, is emerging from a lost decade of growth, and expanded at a 5.5% annualized pace in the fourth quarter or five times faster than the US in the fourth quarter. Exports climbed and consumer spending, bolstered by rising wages and higher stock prices, accounting for more than half of the expansion, and moving the economy into its 48-month of recovery from recession. Japan's jobless rate fell to 4.1% in March, an eight year low.
Japan's industrial output rose for a sixth straight month in January to its highest level since 1998, and imports soared 50% since 2003 to as high as 5.4 trillion yen in December, providing more fuel for the "Commodity Super Cycle." The Japanese economic recovery should continue until next year, said Economic Minister Kaoru Yosano. "The expansion is expected to be far from over, and could easily exceed the longest postwar expansion, which began in 1965 and continued for 57 months."
The Bank of Japan nurtured the "Commodity Super Cycle" for five long years, and inflated other asset bubbles worldwide with a radical monetary policy that flooded the Japanese banks with 26 trillion yen above their legal requirements. On March 9th 2006, however, the BOJ announced that it would begin to dismantle its ultra-easy money policy, but still keep its overnight loan rate at zero percent.
"It's highly likely we will be able to reduce the current account deposits to legally required levels (6 trillion yen) within several months," said Deputy Governor Toshiro Muto on April 20th. Muto said the BOJ had no time table for lifting the overnight loan rate. "I have no preconceptions on when we will end our zero rate policy," and said the central bank would adjust its policy depending on economic conditions.
The "Commodity Super Cycle" was thrown for a nasty 8% correction in February, linked to the sliding Japanese yen Libor futures market in Singapore. Yen Libor futures are predicting the BOJ will hike its overnight loan rate to 0.50% by year's end. However, while the BOJ has received permission from the ruling LDP kingpins to drain excess yen from the banking system, it does not have the green light to lift the overnight loan rate above zero percent.
On April 14th, LDP Chief Cabinet Secretary Shinzo Abe said, "Given that mild deflation persists, the rise in rates has been too rapid and could have a negative economic impact. I would hope the Bank of Japan keeps it's zero-rate policy to support the Japanese economy, and that it clearly explains its policy intentions to investors," Abe said. Finance Minister Tanigaki and Vice-Minister Koichi Hosokawa both expressed opposition to higher Japanese interest rates. A sustained increase would lift the government's interest payments on public debt.
Long-term Japanese bond yields have jumped about 40 basis points since March 9th, when it became apparent that BOJ would drain up to 26 trillion yen from the banking system. With less manipulation by the BOJ, the Japanese bond market may finally begin to reflect inflationary pressures in the global commodities markets. BOJ chief Fukui said Japan's long-term interest rates are reflecting the economic recovery and rising stock prices, noting that long-term interest rates were also rising in the United States and Europe by about the same amount.
Still, Japan's financial warlords cannot stop meddling in the JGB market. As the yield on the 10-year government bond hit a seven-year high of 2% last week, Japanese Finance Minister Sadakazu Tanigaki said on April 21st, "My basic stance is that while mild deflation remains, a rapid rise in JGB rates is undesirable. I am worried about recent movements." The BOJ's Muto sought to calm the Ministry of Finance, "We will communicate thoroughly with the market and will pay attention to movements in long-term interest rates," in a compromise with the ruling LDP kingpins.
In Germany's Europe's largest economy, producer prices jumped 0.7% in February, to stand 5.9% higher than a year earlier, the highest rate in 24 years, boosted by surging energy costs and sharp increases in non-ferrous metals. While the cost of raw materials was posing problems for some German firms, the latest rise in factory prices underlined the fact that Germany was profiting from strong global demand.
On March 30th, European Central Bank chief Jean "Tricky" Trichet was not ready to acknowledge the supremacy of the "Commodity Super Cycle." In a speech to the Institute of International Finance in Zurich, Trichet claimed the ECB has established the credibility of the Euro by anchoring inflationary expectations and would continue to do so, while ignoring the Euro's 50% devaluation against gold since September.
"We are still, and will continue to be, credible, as we were at the first day. Our anchoring of inflationary expectations remains impeccable because markets know we are very, very serious when we are speaking of preserving and maintaining price stability," Trichet said. Yet one week later, Trichet lost all credibility as an inflation fighter, when he ruled out an ECB rate hike in April and May.
Interest rate futures traders are racing to the finish line, predicting a 0.75% hike in the ECB repo rate to 3.25% by year's end. However, "Tricky" Trichet is moving ECB monetary at a snail's pace. On April 6th, Trichet signaled that the ECB would move in slow motion and stick to 3-month intervals between repo rate hikes, and certainly wouldn't be bullied by the fast footed futures traders in Frankfurt.
The ECB is lingering far behind the inflation curve to keep European equity markets buoyant and prevent the Euro from surging higher against the US dollar, which would hurt Euro zone exporters. European finance ministers believe Beijing should bare the brunt of correcting massive US trade imbalances, "Greater exchange rate flexibility is desirable in emerging economies with large current account surpluses, especially China, for necessary adjustments to occur," the G-7 communiqué said.
Because key commodities are traded in US dollars, the Federal Reserve has a special role to play to defend the US currency from bearish speculators with higher interest rates to contain the "Commodity Super Cycle." However, the Fed is also focused on supporting the US housing market, which is becoming lethargic, and the central bank does not want kill the goose that lays the golden eggs for the US consumer.
Fed governor Donald Kohn admitted on April 14th, that the Fed's rate hike campaign is almost out of ammunition. "Overshooting is one of the things we are very aware of as a risk in policy today," noting that it was not good enough to just "look out the window" at current conditions. "The economy is at an extremely interesting juncture," Kohn said. Governor Susan Bies told reporters, "We're closer to neutral than we were a few months ago," she said.
Federal Reserve policy-makers on March 27-28th might have signaled a peak in the federal funds rate at 5 percent. "Most members thought the end of the tightening process was likely to be near, and some expressed concerns about the dangers of tightening too much, given the lags in the effects of policy." However, "with energy prices remaining high, prices of some other commodities continuing to rise, the risk of at least a temporary impact on core inflation remained a concern," the Fed said.
Given the choice of battling the "Commodity Super Cycle" or lending support to US housing prices, the Fed would probably chose to prevent deflation in real estate. But after the Fed moves to the sidelines, neither the Bank of Japan nor the ECB seem determined enough to combat rising commodity prices. The BOJ and ECB prefer to keep their equity markets buoyant with cheap money policies. So, the G-7 central bankers must rely on open mouth operations to confuse commodity speculators.
The slightest hint of a premature end to the Fed's rate hike campaign was greeted with wild jubilation on Wall Street, with the Dow Jones Industrials soaring about 250-points over 3-days to near record highs. The Dow Industrials brushed aside the significant slide in US dollar Libor contracts (Eurodollars) from January thru mid-April which telegraphed two quarter-point rate hikes to 5.00 percent.
Instead, the DJI rallied on ideas that first-quarter US economic growth is racing ahead at a 5% annualized rate, and earnings for Standard & Poor's 500 companies are expected to rise 12.5% to 14% from a year ago, offsetting worries about a 5% federal funds rate. The buoyancy of the DJI alongside rising short term US interest rates is a clear sign that Fed policy remains accommodative, and still below the neutral rate that would steady the economy at non-inflationary growth.
Whenever the Dow Industrials have a bad day, financial reporters are quick to point the finger of blame to higher oil prices. But the Dow Industrials have been largely immune to major oil price shocks. The Fed is afraid to publish its M3 money supply data, but it is quite apparent that US monetary policy is still very accommodative and immunizing the DJI from the negative impact of higher oil prices.
How does one reconcile the DJI climbing towards its all-time high of 11,750, with crude oil trading near record $75 per barrel? Oil prices averaged $39 a barrel in February 1981, or $87 in inflation adjusted 2006 dollar terms. If the IMF's prediction of global economic growth of 4.9% in 2006 is correct, then the global economy could probably tolerate oil prices above $70 per barrel.
With the US housing bubble losing hot air, Fed officials are fumbling for excuses to justify a premature halt to their rate hike campaign. On April 18th, Dallas Fed chief Richard Fisher said explosive gains in oil and gasoline prices were nothing to be concerned about. "From an inflationary standpoint right now, the numbers look manageable if we continue to do our job, so I sleep well at night."
On April 13th, Fed governor Mark Olson remarked, "If oil prices flatten at around $70 per barrel, the drag on real income and spending from rising energy costs should diminish over time, as should the risk of additional energy cost pressure on underlying, or core inflation," he predicted.
"In the longer run, these inflation effects should fade even if energy prices remain elevated, so long as monetary policy keeps inflation expectations well-anchored by responding appropriately to future price and output developments," said Fed chief Ben Bernanke on April 5t. Bernanke conceded that "rising energy prices had pushed headline inflation up sharply, but the impact on core inflation, (which strips out the bare necessities of food and energy), appears to have been relatively modest."
BOJ chief Toshihiko Fukui is closely monitoring crude oil prices and the direction of overseas economies, which could pose a risk to Japan's continued economic growth. On April 17th, Fukui said, "It's highly likely that the Japanese economy will achieve long-lasting, sustainable growth. The BOJ is committed to implementing monetary policy in an appropriate manner to respond to changes in the economy and prices."
With crude oil prices soaring to a record 8800 yen per barrel, and the US dollar tumbling by 3.5-yen to 115-yen in the past three days, the Bank of Japan could decide to slow down its tightening campaign at a moment's notice, to help immunize the Nikkei-225 stock index from a 24% oil price shock since March 20th. The Ministry of Finance would be happy to see 10-year JGB yields below 2%. Futures traders in Singapore might decide to cover some short positions in Yen Libor contracts.
Despite a 21% surge in crude oil prices to a record 71,200 won per barrel, the Korea Composite Stock Price Index (KOSPI) rose to a fresh record high of 1,451 points on April 21st. Signals from the Federal Reserve of ending the two-year climb in interest rates raised hopes for ample global liquidity. Strong global liquidity has been a key factor in the sustained rally in emerging markets, including Korea in recent years.
Bank of Korea chief Lee Seong-tae, said on April 7th, that Asia's fourth-largest economy would maintain its growth momentum despite high oil prices. "With economic fundamentals showing a continued recovery, there is no change in our stance to adjusting loose monetary policy." The BOK left its overnight loan rate unchanged at 4% on April 7th, to insulate the Kospi from oil price shocks.
South Korea is the world's fourth largest oil importer, buys 81.7% of its crude oil from the Middle East, of which 8% comes from Iran, and has 111 days worth of strategic oil reserves to help insulate it from unforeseen external developments. In the event of an Iranian cut-off of its 2.6 million bpd of exports, the United States has 123 days of oil reserves, while Japan and Germany can fuel their countries for 141 and 116 days respectively, without importing more fuel.
ECB chief Trichet has expanded the Euro M3 money supply by 8% from a year ago, to inflate the EuroStoxx-600 index. Commenting on the surge in crude oil prices to a record 61 Euros per barrel on April 21st, Trichet said, "We will continue to monitor very closely all developments to ensure that risks to price stability over the medium term do not materialize. It is essential, from our standpoint, to ensure that medium to long-term inflation expectations in the Euro area are very well-anchored, it is good for growth and for job creation," he said.
But Trichet was careful to couch his comments in obscurity. "It goes without saying that any increase in the price of oil is a materialization of a risk that we have always mentioned, as one of the major risks," he said. Would "Tricky" Trichet decide to delay further repo rate hikes, to help insulate the Euro zone economy and the EuroStoxx-600 index from the 22% oil price shock over the past four weeks?
The strategy of the big-3 central banks, the Fed, the ECB, and the BOJ of insulating their stock markets from oil prices shocks with cheap money policies is backfiring. Instead, the big-3 banks are fertilizing the landscape of hyper-inflation in the commodities market. If the US dollar should begin to tumble due to its massive trade and current account deficits, then the "Commodity Super Cycle" could get an extra shot of adrenalin from a weaker greenback.
Yet in a strange twist of logic, the Persian Gulf Arab stock markets which ranked among the best performing in the world in 2004 and 2005, have crashed to earth in the past two months. The Saudi All-Share index dropped to 12,076 points on April 23rd, slashing the capitalization of the Arab world's largest bourse by more than 42% from its all time high in February. The Dubai Financial Market is 52% off its peak.
The Saudi market was trading on a price-to-earnings multiple above 40 and the UAE was above a P/E ratio of 30, well above their long term average p/e of around 15. But those multiples could be justified by expectations of sharply higher oil prices that are now being realized. However, tension over Iran's nuclear weapons program has battered investor confidence across the world's biggest oil-exporting region.
Other analysts noted a gap between Saudi profit growth of 305% and stock market gains of 450% over the past few years. Thus, despite the outlook for higher oil prices, and a record $150 billion oil surplus for the Gulf region is in prospect for 2006, Saudi share prices had risen too far, too fast, ahead of profits. A correction of share price levels that were 50% above profit growth could be expected.
From a purely technical perspective, the meltdown in the Saudi All-Share Index looks very similar to the meltdown pattern of Japan's Nikkei-225 stock index in 1990. The SASI is searching for a level where bargain hunters would emerge and set-up a technical bounce. However, a third leg down could ultimately be in store, and if correct, bottom pickers could get burned.
And if that were not enough, more volatility lies ahead for energy markets and precious metals, thanks to Iran's Mamoud Ahmadinejad, and his allies Vladimir Putin and Venezuela's Hugo Chavez. "Those rich and industrial countries that have billions of dollars in income should pay the real price for their crude oil," Ahmadinjad said on April 21st, intimating that $100 or more for a barrel of oil was an appropriate level.
Iran's Ahmadinejad has already unleashed the "Oil Weapon" on the industrialized West without cutting back a single drop of oil. Ahmadinejad is firing on all cylinders, jawboning crude oil prices sharply higher by upping his anti-Israel rhetoric and showing off Tehran's close ties with Palestinian and Iraqi militant groups. He speaks of the US as being in a "quagmire" in Iraq, and has no fear of a US attack.
Libya's top oil official Shokri Ghanem said on April 23rd, fears of US military action against Iran had added $10 to $15 to the cost of a barrel of oil. Other producers blame a lack of planning in consumer nations, particularly the United States, which uses a quarter of the world's oil and over 40% of its gasoline but has not built a new refinery on its soil for decades.
Iran's armed forces conducted military exercises in the Persian Gulf and around the oil-supply choke point at the Strait of Hormuz. Iranian General Mohammad Hejazi said on April 3rd, "We showed our capabilities by these maneuvers in the Persian Gulf and Oman Sea. The world's energy supply depends on this region. But if the region is not to be safe, the ones responsible for it will pay a high price. The enemies must know they should not be playing with fire," Hejazi said. Shutting down Hormuz could slow down global shipping and tighten the supplies of commodities.
Ahamdinejad announced on April 11th, that Iran's scientists mastered nuclear enrichment and in a display of total defiance, vowed to reach industrial-scale enrichment capacity within 12 months. "Our answer to those who are angry about Iran obtaining the full nuclear cycle is one phrase, Be angry and die of this anger."
On April 15th Ahmadinejad called for the annihilation of Israel at a meeting with Hamas and Islamic Jihad leaders in Teheran. "The Zionist regime is an injustice and by its very nature a permanent threat to the Islamic world. Whether you like it or not, the Zionist regime is on the road to being eliminated. It is a decaying and crumbling tree that will fall with a storm," he added.
But earlier on March 20th, US President George W Bush warned Tehran he would use military might if necessary to defend Israel. "The threat from Iran is, of course, their stated objective to destroy our strong ally Israel. That's a threat, a serious threat. It's a threat to world peace. I made it clear, and I'll make it clear again, that we will use military might to protect our ally Israel," said Bush.
Iranian hardliners are counting on the Russians and Chinese to block the Security Council from imposing any meaningful sanctions, and seem convinced the Americans cannot attack. Indeed, on April 21st, Kremlin spokesman Mikhail Kamynin said, "We will only be able to talk about sanctions after we have concrete facts confirming that Iran is not exclusively involved in peaceful nuclear activities." China buys 15% of its imported oil from Iran and wants the rights to develop the giant Yardavan oilfields, worth about $120 billion.
Russia's Putin also rejected calls by the US State Department to cancel the planned sale of its Tor tactical surface-to-air missile systems to Iran. "There are no circumstances which would get in the way of us carrying out our commitments in the field of military cooperation with Iran. That includes our commitment to supply Tor systems to Iran." The Kremlin is profiting from tension in the Middle East.
Between 2000 and 2004, Russian exports to Iran increased by 106%, and imports rose by 126 percent. Those figures for China are 159% and 389%, respectively. The leader for trade growth with Iran, however, is France, whose exports to Iran increased by 416 percent. Soaring oil prices have boosted Russia's foreign exchange reserves to a record $208 billion and growing rapidly each passing day.
Iran is the biggest market for Russian arms, including aircraft and submarines. The loss of the Iranian orders could force entire lines of Russian weapons industries to close down. The two neighbors have also signed trade contracts worth $80 billion over the next decade. And Russia expects to build seven nuclear power plants the Islamic Republic wants to set up in the next 10 years.
Russia needs the Islamic Republic of Iran as part of Moscow's effort to curtail US influence in Central Asia, the Caspian Basin and the Middle East. In Afghanistan, Teheran and Moscow are currently engaged in developing a joint strategy in anticipation of an American withdrawal once Bush leaves office. Both countries are reaping huge rewards from oil exports to industrialized nations.
And adding more volatility to the crude oil market, Venezuelan President Hugo Chavez accused the Bush administration on April 19th, of planning to invade Venezuela, with a recent deployment of US warships in the Caribbean Sea. "They are doing maneuvers right here. This is a threat, not just against us, against Venezuela, but also against Cuba," the mercurial Chavez warned.
What could be the early warning signals of a correction for the "Commodity Super Cycle" in the future? The answer will be published in the May 1st edition of Global Money Trends magazine. Subscribe today and click on link below.
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