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VOLUME 4 ISSUE 16
March Pending Home Sales jump 4.1% m/m March Durable Goods Orders lower on aircraft February Case-Shiller House Price Index rise March New Home Sales gave back February gains April CBO Consumer confidence index falls Q1 initial jobless insurance claims gains gone Mar China HSBC flash PMI higher still sub-50 Mar China imports lower on payback to Jan-Feb gains
The commodity supercycle is ending? China isnt all that matters, Part 2
There has been a lot of debate about the end of the "Commodity Supercycle" in recent days. The subject came up along market speculations that a hard landing will take place in China, and that the "miracle" is "over. The premise here is that if the infrastructure development of China is over, then surely the so-called "Commodity Supercycle" is over. Could this meme be correct? We disagree with those notions on five counts: (1) We do NOT believe that China is in for a hard landing (we expect higher growth in Q2 2012), and (2) even if Chinas growth ratchets down from "boiling" to "simmering" that does not necessarily mean an end to the upward trend in commodity prices as other emerging countries and even OECD economies would soon take up the "slack" from Chinese demand moderation; (3) a China paradigm shift from investment to consumption does not necessarily derail the commodity gravy train -- it just rearranges the order and the number of the train cars; (4) the Feds reaction function almost guarantees that rates will stay low too long again, and will likely re-ignite inflationary pressures in a 1970 context; and (5) the "commodity supercycle" being discussed is not really a "Supercycle", but only a boom in a longer, larger, higher-amplitude period of economic activity (the Long Wave or Kondratief (K) Wave) which could top out in sometime in 2022-2026.
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lags in the economy, information limitations, and bounded rationality in economic decision-making -- all of which creates/ causes potential/actual oscillatory behavior; and second, a wide range of self-reinforcing processes exist which amplify the inherent oscillatory tendencies of the global economy (e.g., capital investment, labor markets and workforce participation, real interest rates, inflation, debt, savings and consumption, and international trade) leading to so-called "Long Waves" or as is more well-known in economic circles, the "Kondratief (K) Waves". It is important to understand that a full-scale Commodity Supercycle within the K Wave is not comprised of one continuous uptrend in prices, but is composed of several booms or boomlets, with different economic signatures and profiles. The commonality that binds these booms and boomlets is the process
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or combination of processes that cause the "Long Wave" in the first place. The variances in the signatures or profiles of these booms and boomlets within the "Long Wave" is consistent with the evolution of macro-economic conditions and their effect/consequences (the phases or the "seasons") within the broad sweeps of a 50-60 year long (Super)Cycle of economic activity. An in-depth discussion of the "Long Wave" or "K Wave" is not germane at this point, and we will leave it for another report in the near-future. What we want to accomplish in this study is to pinpoint where we are in the current cycle, and whether or not we expect the boom/boomlet to continue, and if yes, for how long. To borrow a phrase once used about business cycles, it can be said that "the study of commodity booms necessarily begins with the decomposition of these booms". For our purposes, we will limit our analysis to
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yet. In this boom, the explosive growth of Chinas and Indias raw materials demand has played a key role. The first two booms collapsed as the world economy went into recession and excessive inventories were sold out. The third boom wobbled in 2008 at the height of the Great Recession (GR), but higher commodity prices since then resumed their course, made new highs in 2011 and may extend once more on loose global monetary policy, even as commodity inventories remain under tight supply constraints. Macroeconomic contexts of the three booms
The insecurity prompted a widespread build-up of straIt is a noteworthy observation that the growth of GDP and industrial production/capacity tegic raw materials inventories, which added to deutilization accelerated strongly in the periods just preceding or marking the beginning of mand and pushed up prices. Purely speculative dethe three commodity booms. It is equally interesting to note that the end of the first and mand also contributed to the asset markets' strength, second booms characterized by substantial falls in commodity prices in 1952 and 1980,
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ing? Not if the Fed runs true to form" Part 1, The Diapason Capital Markets Report, April 19, 2012). The ensuing surfeit of liquidity for periods longer than necessary triggered a massive inflationary run. The very high inflation through the duration of the second boom provided further dissimilarity from the first commodity boom. Not only did the period record very strong price rises, irrespectively how measured, for raw materials as well as for manufactures. The years were also characterized by chaotic changes in the parities between major currencies, all of which were freely floating after the dollar anchor had been removed and the dollar itself was made non-convertible to gold in 1971. Measured by CPI, inflation totalled no less than 305% over the 12-year period, a sharp contrast to the first commodity boom. Rampant inflation brings on negative real rates The rampant inflation which had resulted in negative real interest rates for long periods, the chaos in currency markets and the poor performance on the stock exchanges in the early 1970s led many investors to move out of bonds and shares and into real estate, art, commodities, and gold. The speculative demand for commodity inventories as a
The second commodity boom (1968-1980) The second boom was much stronger than the first. It was also much more pervasive in that the prices of all commodity groups rose sharply. Similar to what happened in the first boom, a very strong macroeconomic performance during 1972 and 1973 constituted an important trigger to the rising commodity prices. But there were three additional triggers. First trigger was that the boom had been preceded by two consecutive years of widespread crop failures, on which a dramatic cut in Peruvian fishery was superimposed. Perus anchovy catch declined from 12.6 million tons in 1990 to 2.3 million in 1973. The scarcity of food led to substitution in land use, e.g. from cotton to grains, which resulted in falling agricultural raw materials supply. The year 1973, therefore, saw deficient inventories both for food and agricultural raw materials.
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safe store of value was a further contributory factor to the commodity and gold boom. The aggregate commodity price index in nominal dollar rose sharply in 1973, and remained above a 250 average through 1974 and 1975 -- the energy index was at about 330, all the other commodity indices around 150. In the course of 1974, under the weight of the recession prompted by the oil crisis, the constant dollar metals and agricultural raw materials indices fell back sharply, to end the year at 100. They remained at that level through 1975, when the recession deepened. The metal prices were additionally depressed by large sales between mid-1973 and mid-1974 from the US governments strategic stockpiles, and in late 1974 from excessive commercial stocks in Japan that had been built up in the preceding year. Rising crude oil prices did most of the damage Energy prices rose significantly at the end of 1973, slightly later than the prices of other
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Diapason Commodities Management UK LLP 18 Upper Brook Street 5th floor London W1K 7PU United Kingdom +44 207 290 2260 www.diapason-cm.com
_________ Mark McDonnell Institutional Sales Tel: +44 207 290 2263
mark.mcdonnell@diapason-cm.com
The Diapason Capital Markets Report is published and edited by Robert Balan, Senior Market Strategist
Robert Balan has more than 3 decades of experience in the financial markets. Education in mining engineering, computer science, and training in economics led to a commodity analysis career during the commodity boom of the early 1970s. Robert made a switch to global macro focus in the early 1980 when the commodity bull market waned, with specialization in foreign exchange. Robert wrote a very high profile daily FX analysis while Geneva-based in the mid-1980s (the first FX commentary with a real global readership, "most accessed" in the Reuters and Telerate networks from 1988 to 1994). He worked for Swiss Bank Corp and Union Bank of Switzerland (precursors of todays new UBS) as head of technical research and proprietary trader in various major finance centers (London, New York, and Toronto) from late 1980s to mid-1990s. A stint at Bank of America as head of global technical research (London, New York) followed in late 1990s to early 2000s. He returned to Switzerland in 2004 as head of technical research and strategy, and FX market analyst for Swiss Life Asset Management in Zurich. He joined Diapason Commodities Management in 2008 as senior market strategist utilizing macro-economic drivers, structural/technical data in modeling asset price and sector movements. Robert wrote a book on the Elliott Wave Principle in 1988, hailed by the London Society of Technical Analysts as best book ever written on the subject. Robert is a member of the National Association for Business Economics (NABE), USA.
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