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Tuesday May 16, 2006 - 09:09:17 GMT
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Commodities correction?

"The only point in making money is so you can tell some big shot where to go.”

Humphrey Bogart

FX Trading – Commodities correction?
Besides the fact that metals got pummeled yesterday, and the dollar rallied accordingly, was the way the “I told you so” pundits emerged from the woodwork with “commodity bubble stories” in hand.

It reminded me of when a big-time movie star or politico dies. The reels of film about their lives, prepared months in advance, hit our television screen the moment said star is pronounced dead. There have been those embarrassing moments when the reels have been queued up prematurely.

Though know one really knows whether a correction is the beginning of a change of trend, it seems a bit odd to see so many analysts jumping on the commodity bubble-ology train. Does that tell us there are plenty of skeptics out there (like me) who haven’t capitulated to the trend? If so, the trend could have more room to run. But without Mr. Hindsight here to guide us, we just don’t know.

Even a small retracement of this move is a big move (25% retrace comes in at 614; while 38% is at 551):

Though not valued for his predictive qualities of late (but then again, few of us really are), Morgan Stanley Guru Stephen Roach penned the following yesterday; it makes some sense, we think [our emphasis]:

“Asset bubbles have dominated financial market experience over the past six years. The world is now in the midst of another bubble -- this one in commodities. It, too, will burst. The only question is when.

“…This is a great story -- in fact, one that I have been telling for quite some time myself [the China juggernaut story]. The problem with the story -- like most tales of new eras -- is that it, too, has its limits. The key here is to realize that China is not going to keep increasing the commodity-intensity of its GDP growth. In fact, in the just-enacted 11th Five-Year Plan, the Chinese leadership announced explicit targets to reduce its energy content per unit of GDP by 20% over the next five years. China’s concerns go well beyond oil. Potential bottlenecks of industrial materials, together with sharp increases in input prices such bottlenecks trigger, are viewed as a serious threat to sustainable economic growth. It is not that difficult for China -- or any country in the developing world -- to improve the commodity efficiency of its economic growth. After all, China currently consumes twice as much oil per unit of GDP as the developed world, on average. Technological change has long focused on reducing the energy and commodity content of manufactured products. In its rush to develop, China has lagged in deploying oil and other commodity-conserving production technologies. The Chinese do not have to develop new technologies to enhance commodity efficiency -- they merely need to copy those already in existence elsewhere in the world. Great at copying and courtesy of higher input prices, China’s appetite for industrial materials seems likely to diminish in the years ahead.”

“When” of course is the $64 billion question! Many of us knew the Nasdaq-mania would end badly; we just had no clue on the timing.

For now it seems the higher probability bet is the move in metals is a correction. It is a correction that caught many off guard, especially those plowing into dollar short—gold long positions. Ahhh…Mr. Market strikes again. Isn’t he grand!

One thing good about what might be premature “commodity bubble” punditry is the fact that some sober facts, instead of cheerleading stories, may be allowed to emerge. We found this interesting tidbit buried in a recent Asia Times online story regarding China’s forex policy [our emphasis]:

“Beijing's think-tanks have made various proposals on the disposal of the foreign-exchange reserve. Some Chinese financial experts have suggested that Beijing increase its gold reserves. Since last year, periodic market rumors that "China is increasing its gold reserves" have triggered climbs in the price of the precious metal.

“However, PBoC data show that from December 2002 to March of this year, China's gold reserves have remained unchanged at a level of 19.29 million ounces, which are only worth some $14 billion given the current gold price of about $700 per ounce. So even if China doubles its gold reserves at current prices, it only has to spend a small fraction of its foreign-exchange reserves.

The gold bulls will read the above and say: See more evidence that there is plenty of buying power left in this gold market. The skeptics will say: Maybe, but wasn’t Chinese gold buying already one of the key reasons given for this move in gold?

And so it goes…

What we can say, in an attempt to bring this back to something related to currencies, is that if we are in the midst of a metals correction—of the multi-week variety, the comdols appear vulnerable:

Remember, one day does not make a trend; but keep in mind that nothing says it can’t be the beginning of one.

Jack Crooks, Black Swan Capital
Black Swan Subscription-based Service


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