China Scours Planet for Commodities

Copyright © 2009, Greenwich Financial Management Inc., a registered investment advisor.

We recently discussed China's nervousness about the safety of US assets, which has been reflected in lesser demand for US Treasuries and Agencies and a shortening of maturities they are willing to buy. While the Chinese have been losing appetite for any more servings at the all-you-can-eat US Treasury banquet, they have been buying raw materials, resources and precious and non-precious metals voraciously. These two trends are organically connected.

Chinese demand has contributed to huge rallies in the markets for precious metals, carbon fuels, industrial minerals and even some agricultural products. "Commodities and shipping executives describe Chinese stockpiling in recent months of a range of other commodities as well, including aluminum, copper, nickel, tin, zinc, canola and soybeans. Starting in April, China began stockpiling significant quantities of crude oil." Source: Some See China’s Buying Spree on Commodities as Short-Lived - NYTimes.com (6/10/2009).

Chinese demand stemmed from more than one source. Some companies bought metals in anticipation of a rise in spot prices as the world economy recovers. The Chinese government, according to the Times article, supported domestic processors by buying heavily in canola oil and aluminum. The Chinese Central Bank has reportedly been a big buyer of precious metals, including gold. To the Central Bank, precious metals represent an alternative store of value that compares favorably with US dollar assets.

There was fear that the Chinese buying would be short-lived, that China would soon suffer a huge glut in raw materials and finished goods. When the inevitable adjustment came, Chinese demand for commodities would plummet, according to this line of reasoning. However, the apparently effective economic stimulus program in China has brightened prospects. Although many Western sources predicted China would not meets its 8% higher GDP growth target in 2009—perhaps growing at about half that rate—more recent forecasts suggest growth will exceed 9%. If anything, there are signs of over-stimulation, inflation and questionable state bank lending practices: a liquidity boom.

Those who buy US Treasury and agency securities take three kinds of risk. The first is that they will not be repaid. This risk has become more salient. For example, holders of Fannie Mae and Freddie Mac preferred shares (including the Chinese government) have seen the value of their securities fall almost to zero, as these agencies suspended their dividends indefinitely. The second risk is inflation and rising interest rates in the US; this risk correlates with the length of the obligation. As rates rise, the value of existing US Treasuries falls, reflecting the ability of investors to receive a higher coupon rate from new issues than from outstanding ones. The third risk is a fall in the value of the US dollar relative to other major currencies, such as the Euro, the Yen, the Swiss Franc, and the Pound.

The Chinese understandably wish to diversity their assets and risks. In addition to purchases in the commodities markets, Chinese industry has been scouring the world to secure resources--in Africa and Latin America as well as the developed countries. These acquisitions stir insecurity among those who are not yet reconciled to China's status as a great power. China faces daunting challenges, including population control, ethnic unrest, environmental degradation and political reform, but its dynamism and the discipline and talent of its people are undeniable. Just as the United States was known as the American Century, the 21st may well be known as the Chinese Century. In coming articles, we will discuss how US investors can diversify their own portfolios to take these trends into account.

Andrew Szabo CFA is managing director of Greenwich Financial Management Inc., a registered investment advisor. Questions call 917-796-8500 or e-mail Szabo@GreenwichFinancial.com). For more information, please visit http://greenwichfinancial.com/.

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