Commodities: China Had a Wildcard

Includes: FXI, SLV
by: Glen Bradford

Getting Stopped Out

All you silver longs can breath a sigh of relief -- for now. I've closed my short position and am looking to figure out which way I'm supposed to go next. The jobs report apparently was significant enough to put in a floor for silver. Personally, I don't think that's what did it. I think it was China's backhanded comments towards the United States about our deficit.

Rationality: Out the Window

Unfortunately, even though I think silver should likely head lower if you simply consider the mania, rationality isn't very important when you have a country that judges the success of its local provinces based on how much concrete they pour that fiscal year. China simply cannot handle a commodity collapse, considering it's been stocking up on them as a store of value as a way to diversify away from the dollar. What would you do if 50% of your GDP relied on building overvalued buildings? Would it be in your interest to see commodity prices come down?

The domino effect

And so you have a situation where China continues to believe that its policy of heavily investing in hard assets and driving up the prices is sustainable, when it's not. To do this, it needs to keep beating down the dollar. Commodity prices cannot fall without being checkmated by China's follow-up notice that it doesn't like US policy and is concerned about the US deficit.

Where we are

And so here we are. If commodities continue to show weakness and the dollar starts rallying, I'd expect to see China in quite a pickle. As for now, it's playing this poker game like an all-star. China needs a weak dollar, and if it can spook the market with actionless words, that's a great wild card to have. A weak dollar supports higher commodity prices. China also will be pegging its yuan/RMB to our dollar, and that will keep the dollar from going too low. It's doing this to stimulate exports.

Things that aren't sustainable unwind fast

As you've seen how quickly the silver bubble collapsed recently, there are other bubbles out there that very easily could have started to unwind if commodity prices continued to fall. Unfortunately, commodity prices aren't high enough to choke off enough demand to make a fall sustainable at this point in time -- or so it appears. At this point in time, I'm not a buyer or seller of silver. I wasn't going to be the person who tried to stand in front of the jumbo jet of unwinding silver prices, but it looks like China certainly was, as it's in its best interests to keep prices going up. How else is it going to continue with its real estate bubble madness?

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.