Risk premiums in copper stocks are on the rise which seems most attributable to market jitters surrounding Chinese monetary policy. Will the Chinese overshoot causing a double dip? I doubt it for a couple of reasons. My first point is that the Chinese have very limited sovereign monetary policy. Secondly, given point number one, recent changes in Chinese monetary policy should be thought of as fine tuning rather than gestalt shifts. Finally, until either the Federal Reserve raises the Federal Funds rate OR China allows their currency to appreciate meaningfully in short order … inflationary pressure in China will persist and growth will persist as well.
My first point: China has a very limited sovereign monetary policy. For quite sometime China has manipulated their currency to remain pegged against the USD. In effect this directly links Chinese monetary policy with US monetary policy. The impact of this pegging policy has allowed China to accumulate significant U.S. dollar denominated assets while creating the most productive, a.k.a. cheapest labor force, in the world. While this policy was seemingly stellar for almost everyone involved (i.e. international companies and the American/European consumer), the bill for China has finally arrived. Over the past decade a severe bifurcation between the U.S. economy and Chinese economy has led to a decoupling of appropriate monetary policy between the two countries. Now China is experiencing significant inflation and it is coming at a time when their Chinese populous is gaining influence to some extent-which is to say the threat of uprising may be on the rise.
Secondly, at the point you agree that Chinese monetary policy is inextricably linked to U.S. monetary policy, what the Chinese have done with recent changes should be thought of as fine tuning rather than gestalt shifts. Ben Bernanke gave a speech recently with a Q&A afterwards and a reporter (or club member) asked him about the very topic of inflation exporting. In essence Bernanke’s response was:
- U.S. monetary is not the factor most attributable to rising commodity prices globally,
- The Federal Reserve is not responsible for monetary policy in the emerging economies, and
- China has all the tools necessary to curb their inflation issues namely by floating their currency higher.
Visually, all I could think of while hearing this comment was a person having their face pushed into a muddy puddle of water by someone’s foot while they are laughing about it (FYI the U.S. is the foot, China is the face). While Bernanke is far too politically correct to think such things, one has to wonder how much enjoyment the Fed is getting out of watching China squirm with inflationary pressures. Perhaps a better analogy is the scene in "G.I. Jane" when the Navy Seal instructors, playing the role of kidnapper/hostiles, are dislocating a trainee’s knee cap as they demand information …“all you have to do … and the pain will stop”. In this case, U.S. monetary policy is providing more incentive for China to allow their currency to appreciate than Chuck Schumer could provide in 100 years of criticizing.
It does appear that U.S. policymakers are making every effort to persuade China to allow their currency to appreciate meaningfully. The cover story in the February 8 Financial Times was about this very point. In the FT article Joe Lehy reports that the U.S. Treasury Secretary is trying to show aligned interests with the U.S. and Brazil, the increasingly influential power house of South America, which is common problems with Chinese currency policy. Perhaps if several other South and Central American countries express the same concern it might actually start to present persuasive case for China to make a meaningful change … although I don’t think I will be holding my breath.
Finally my third point, with Chinese monetary policy inextricably linked to U.S. monetary policy, Chinese interest rate hikes and reserve rate hikes, etc., will do very little in terms of disrupting the tremendous growth in China. If anything they will actually serve to slow the trajectory of the frothiest areas of growth BUT that does not equate to a full meltdown for copper demand. From a global perspective China will remain demonstrably more competitive than the rest of the world for the production of cheap goods until such time as the U.S. Federal Reserve becomes less accommodative (which does not seem likely for some time yet) or they raise their own currency value. As such, companies in China are going to continue growing at a very robust pace – thus the rise of the Asian middle class will still be intact despite interest rate hikes in China. This could all change, but I that would mostly likely be seen in a breaking the link between Chinese and U.S. monetary policy.
My take: While I understand investor trepidation towards copper mining stocks in the face of interest rate hikes and inflationary fears in Asia, those fears seem misplaced so long as China relies on the U.S. to conduct its meaningful monetary policy. All of this leads me to conclude that it would still do many investors well to take a glance at my article on the fundamentals of copper for 2011.
The bottom line is that copper is not only a supply constraint bull story, it is a long-term demand bull story. Copper stocks are among the most volatile out there so despite the bullish long term fundamentals it would not be very prudent to load up 90 percent into copper stocks, but I still think scaling into a long term structural position in copper companies will serve you well when you look back in 3, 5, and 10 years. As Dennis Gartman would say, the trend remains from the lower left to the upper and as such weakness is to be bought until further notice.
Good luck and thanks for reading.
Disclosure: I am long FCX, SCCO, VALE.