News out yesterday suggested that Japan’s industrial production surged 14% in the three months ending May 2009. This is yet more positive news and another factor that demonstrates the global economy is not in free-fall and is rebounding from the “collapse” of late last year. In a recent blog Calafia Beach Pundit had this to say about the sequence of events that led to the crash in industrial output last year and the pick-up in the last few months.
The down-sequence goes something like this: global demand collapsed as fear of widespread bank failures swept the markets; counterparty risk blew sky-high, with the result that banks stopped writing letters of credit; without letters of credit, global trade ground to a halt; as inventories built up, production was slashed. The up-sequence began early this year: Financial markets began to recover, as swap and credit spreads declined and liquidity returned; with counterparty risk rapidly declining, banks began writing letters of credit again; with letters of credit, global trade resumed; with confidence returning, demand started picking up; inventories began declining; and finally, with inventories declining, manufacturers are once again ramping up production. Evidence of this process can also be found in the rise this year of the prices of commodities, energy, and equities.
It is interesting to note the performance of the TOPIX Wholesale Trade Index. This is an index made up of infamous trading houses like Sumitomo, Mitsui & Co, Marubeni, Mitsubishi, and ITOCHU. These companies are essentially middlemen for commodity producers and commodity consumers so the performance of these stocks gives a good indication as to the level of economic activity in Japan (and by default the world). The pickup in Japanese industrial production was not really a surprise given the strength of the Japanese Trading houses. Yes there has been some weakness over the last three weeks but that is not anything out of the ordinary:
Is the recent bull market in commodities about to fall flat on its face? What is the market telling us? Let’s look at the “strength” of the bull market in commodities in more detail……from a market perspective. We will look at the performance of the commodity market itself, at indicators of inflation, at indicators of industrial activity/world growth and indicators of “commodity” capital flows.
- The broad commodity market, as indicated by the CRB CCI index (an equally weighted index of 17 commodities) has fallen by some 7% over the last month. However, there is little to suggest that the current weakness (based on looking at this chart alone) is nothing more than the market’s attempt to “shake out weak hands”. What would have to happen to the CCI for us to stand up and admit we are wrong on our bullish stance? In essence a break below 375. That would breach critical support for the uptrend and it would turn the 100 day rate of change negative.
- Inflation indicators. Inflation protected US Treasuries continue to outperform non inflation protected treasuries. If inflationary expectations were breaking down (i.e. deflation) then we would expect to see an obvious breakdown in the performance of TIP (inflation protected 10 yr treasuries) vs. the US 10yr. The graph below does not suggest that there has been a breakdown of inflationary expectations. This is supportive of commodity prices.
- World Growth. Let us look at emerging market equities relative to developed markets. During times of economic growth emerging markets tend to do a lot better than developed markets…….so outperformance of EEM vs. the S&P Global 100 (IOO) should suggest a bullish environment for commodities. The graph below clearly suggests outperformance by emerging markets. And the weakness as of late? We don’t expect the relative of EEM/IOO to move up in a straight but it should conform to a pattern of higher highs and higher lows…..which is what we have.
Let us also relook at Baltic Freight Rates. The Baltic Dry Index remains well supported in an uptrend and (for now at least) does not appear as if it wants to move lower. An uptrend in freight rates is supportive of world growth and higher commodity prices.
- Emerging Debt tends to be a leading indicator of commodity prices….emerging market bonds remain strong at multi-week highs.
- And Finally – the performance of “commodity currencies”. Let us look at the Brazilian Real and the South African Rand (we could also include the Aussie, Kiwi, Ruble but space does not permit). If there is any disbelief the “commodity story” it would show up right quick in the Rand and Real (even in Euro or Yen terms). Yet both the Rand and Real remain strong (and are doing as well as the Aussie).
| Our conclusion from the charts above is that the weakness we have witnessed in the commodity market is not the beginning of a tradable downtrend. It is merely a short term correction of an overbought condition. |
So subscribers we remain resolute……..and no change to our bullish commodity positions (which are many and varied).
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