Will China's slowdown really sink the commodities market?
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It was all going so well.
After taking a dive at the start of the week, world stock markets recovered some of their poise mid-week. By Thursday's close, the FTSE 100 looked as if it had a good chance of ending the week higher than where it began.
And then another Federal Reserve banker decided to open his mouth and state the obvious yet again…
William Poole, the president of the Federal Reserve Bank of St Louis, ensured stocks ended last week on a low note when he pointed out that “core inflation is modestly above what many of us have expressed as our comfort zone.”
Speaking to reporters in South Korea, he continued: “It’s certainly my view that if the inflation rate continues to be persistent like that, the Federal Reserve will simply have to pursue [anti-inflationary policies]."
Let’s leave aside the fact that the idea of an anti-inflationary central banker is something of an oxymoron. After all, they're the ones who've been printing all this money and driving prices higher in the first place.
Mr Poole’s comments reawakened all the insecurity that had briefly been set aside mid-week. Traders had become resigned to a fresh US interest rate hike at the end of this month, but now they are getting worried that another will follow sharply on its heels.
But the renewed nerviness wasn’t just down to Mr Poole. China did its bit to rattle investors at the end of a long week as well, by announcing its very own bit of financial tightening.
The People’s Bank of China raised its “required reserve ratio” for commercial lenders by 0.5% percentage points, to 8%.
Basically, this means that commercial lenders will be able to advance fewer loans, because they will need to keep more money in their reserves. The hope is that this move will help to slow investment in unnecessary factories and infrastructure projects.
This is far from the only measure designed to slow investment growth, says Julian Jessop at Capital Economics. In April, the Chinese central bank hiked the key interest rate to 5.85% form 5.58%, reacting to strong economic growth in the first quarter.
“Further…controls [on lending] may well be coming. Individually, none of these measures is likely to make much difference, but as a package they should have more bite,” says Mr Jessop.
This news hit mining stocks in particular – investors are concerned that if China’s economy starts to slow down, then the country’s demand for raw materials will also fall, driving down commodity prices.
So is the market right to be punishing the mining sector?
We don’t think so. As highly respected financial commentator David Fuller points out on Fullermoney.com, the commodities story isn’t just about China – “it now emanates from most of Asia, South America, much of the Middle East, Eastern Europe and even Africa.”
Unsurprisingly, the populations of these developing economies want the higher standard of living that they see in the West. And that demand will require a lot of raw materials to sustain it.
As Mr Fuller puts it: “You don’t need to be a mining analyst, let alone an economics wonk, to appreciate that when 5.5bn mostly impoverished but naturally intelligent and often highly educated people are encouraged to lift themselves out of shanty towns or rural squalor, and into the gleaming cities and higher paid careers that 1.5bn people in the developed world have mostly taken for granted, the newcomers embrace this opportunity with considerable zeal.”
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He believes “we are only a few years into what will surely be the biggest and longest bull market for industrial resources that the world has ever seen.”
But if you want to worry about bubbles, there are certainly plenty of them around just now. In the commercial property sector for example, Jenny Davey in The Times reports that property developers are planning to build the equivalent of 33 shopping centres the size of Bluewater (Europe’s largest shopping centre) in the UK over the next four years.
More than 18 million square feet is already under construction. That’s the most since the period from 1989 to 1991, when 19 million square feet of new shopping space was built - just before the property crash of the early nineties.
All this new building is going on at a time when consumers have never been more indebted, and the high street is looking increasingly vulnerable. Perhaps more importantly, it’s also occurring just as retail outlets are losing significant levels of market share to the internet.
We don’t think the UK needs more shops. But we do think the world needs lots more raw materials. So although the mining sector correction may well continue while markets remain confused and scared about a US-led slowdown in China, remember that’s all it is - a correction, not a crash.
Turning to the wider markets...
The FTSE 100 slipped back on Friday, losing 21 points to close at 5,597 as mining stocks reversed early gains. BHP Billiton shed 2% to 960p. For a full market report, see: London market close
Over in continental Europe, the Paris Cac 40 fell 29 points to 4,694, while the German Dax fell 46 to close at 5,376.
Across the Atlantic, US stocks were mixed on inflation concerns. The Dow Jones Industrial Average was flat at 11,014, while the S&P 500 fell 4 to 1,251. The tech-heavy Nasdaq shed 14 to 2,129.
Inflation fears and China's tightening also hung over traders in Asia. The Nikkei 225 fell 18 points to 14,860, with exporters once again among the main losers on fears that the Federal Reserve will tighten too far and push the US economy into a slump.
This morning, oil was lower in New York, trading at around $69.50 a barrel. But Brent crude was higher, trading at around $66.85.
Meanwhile, spot gold was trading at around $570.50 an ounce, as the dollar remained solid amid rising interest rate expectations. Silver was also lower, falling to $9.95 an ounce.
And in the UK, Lloyds TSB has said it will see "satisfactory earnings growth" in the first half of 2006, although bad debts are set to rise further.
And our two recommended articles for today...
When will gold resume its bull market?
- Stock markets have been battered by the prospect of further interest rate hikes in the US. But at the same time as everyone is worried about inflation, the monetary supply has actually decreased, says gold commentator Paul van Eeden. To find out how he plans to invest during the current confusion, click here: When will gold resume its bull market?
What Latin American nationalism means for miners
- The wave of nationalisations sweeping Latin America signifies more than another disaster in George Bush’s foreign policy. With 8.5% of the world’s oil supplies and vast reserves of base metals located in the continent, the nationalisations could have a dramatic effect on supply. Investors in mining and energy stocks should certainly be wary - shares in vulnerable miners have plunged as governments seize control of deposits. But as always, there are opportunities lurking for the canny investor. To find out where, click here: What Latin American nationalism means for miners
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