Not The Time For Investors To Panic Over China And Commodities

Includes: DJP, FXI, GLD, IAU
by: Hard Assets Investor

By Amine Bouchentouf

In the late 1990s, as the dot-com bubble burst and once-high-flying tech stocks came crashing back down to Earth, another important global macroeconomic event was taking place across the globe that would have far-reaching implications for the world economy for years to come: the rise of China as an economic superpower. While the two events aren't necessarily correlated, the latter has had a major impact on global economic output, with a specific effect on commodities.

It is not a stretch to claim that China may now be the most important global driver in the commodities markets. For instance, China now accounts for more than 30% of consumption in key base metals such as iron ore and copper. China is on track to import more crude oil than the United States next year, a fact that would have been quite unthinkable in the late 1990s. And China is the largest purchaser of many soft commodities, such as soybeans and corn.

Many countries have depended heavily on the Chinese consumer market for these raw materials, which has helped countries in the Persian Gulf, Latin America, and Africa to ship gargantuan amounts of raw materials to the Asian nation. In the process, many governments in these countries ran up huge trade surpluses and many businessmen generated lots of value by taking advantage of this unique trade wave.

Troubles in China?

As the saying goes, whatever goes up must come down, and China has been on an uptrend year in and year out for over a decade. As many countries were relying on Chinese growth above double digits, when that growth is removed, a lot of people start feeling the pain. The weakness we're seeing right now in the commodities markets across the board can be traced back in some form to the decline in Chinese economic activity.

China is expected to grow 7.7% this quarter, well below the double digits of a few years ago, and also below the 7.9% from this quarter. While any country would be envious of enjoying growth in the high single digits, those numbers are so ingrained in economic models that even a slight miss will have a devastating impact on industries relying on that growth -- and this also includes commodities.

As Chinese growth has been revised downward by many banks and economists around the world, commodity prices have been suffering. The S&P GSCI Index is down almost 8% this month alone, dragged down by key commodities such as copper and crude oil. Silver is down more than 20% so far this year, WTI crude is now trading at $88 a barrel, and even copper is down to 18-month lows.

While a lot of commentators have been focused on the fall of gold (which is a major story in and of itself), the bigger story is the weakness of commodities as an asset class we're seeing right now. At the end of the day, the asset class of commodities is the ultimate barometer of where the global economy is heading -- and right now that doesn't seem to be a very upbeat picture.

What Should Investors Do?

In this time of panic, it's very easy to get sucked down by negative sentiment. However, this is the right time to be setting up trading positions that will benefit in the long term. Baron Rothschild, the famed 19th century banker, used to famously say that the best time to buy is when there is blood in the streets. Andrew Carnegie, who created a vast steel empire, was known to invest heavily in down markets -- which helped him become extremely successful.

Commodities as an asset class, and specific commodities in particular (such as gold), have been on a steady uptrend for a decade (the 2008 financial crisis being an exception). It is absolutely normal that we see this correction. Take gold, for example: Gold has not had one negative year in 12 years. For long-term gold bulls, you actually want gold to have a couple of bad years in order to stabilize the trend and take the froth out of the market.

China is currently experiencing a period of relative weakness -- I say "relative" because any country growing at more than7% per year isn't demonstrating economic weakness. And this "weakness" is spilling over into the commodities markets.

However, demand for natural resources as a whole is a long-term trend that is supported by one of the greatest urbanization and industrialization drives history has ever seen -- which is responsible for moving literally billions of people from rural poverty to middle-class urban areas. Should this trend begin to falter, then investors should be extremely worried. Since that isn't the case, this is only a temporary pullback in what is a long-term secular bull market in commodities.