Don’t Bet Against Chinese Commodity Bull

Montreal, Canada

A correction in asset values is now engulfing the natural resource space. If everyone was bullish just eight weeks ago, then the opposite is true now. Suddenly, the world doesn’t need as much oil, wheat or potash compared to only two months ago.

Even governments are getting into the act. The release of strategic oil reserves is another stupid policy by major leaders of the world at a time when prices are already falling since May.

In the span of almost seven weeks everything from oil companies to fertilizer stocks has been trashed by the herd on fears of a Greek default, a Chinese economic slow-down and a softening American economy. All this bad news is converging at the same time.

Apparently, the global growth cycle is at risk once again and confirmed by the rapid flattening of the yield curve in the United States, a big rally in TIPS (suggesting renewed deflation fears) and another rally in the U.S. dollar – consistent with the “risk off” environment now pervading across world markets.

Focus on China. The Chinese are the number one consumers of raw materials in the world over the past decade and continue to absorb whatever excess supply is left unused by other big consumers like the United States, Germany and Japan.

But the Chinese economy isn’t falling off a cliff. Noted China-bear, Jim Chanos, an excellent short-seller, believes China’s property market is a deluded nightmare in mispricing.

The bears point to a bubble in Chinese real estate, now clearly deflating. I can’t argue with that. But the bears are wrong to assume China’s economy will crash; the People’s Bank of China can mop-up non-performing loans in the banking system with one push of a button.

China sits on more than $3 trillion dollars’ worth of reserves.

Not only can she subsidize non-performing loans overnight but equally impressive is the fact that China is a net creditor nation. Many countries would have no problem lending to China because her external balance-of-payments is in surplus and net debt still very low compared to other nations, especially in the West.

Also, nobody really knows just how much gold China holds in her reserves.

Recently, Hong Kong recalled its gold stash from London. I’m betting the Chinese are quietly but regularly amassing a fortune in gold bullion and absorbing any supply the free market unloads, not including her domestic production, now the world’s largest gold producer.

There’s no debating inflated real estate values are prevalent in China; there’s real trouble. But let’s not forget that even the United States while on the road to becoming the greatest economic power since the Roman Empire, suffered major depressions in the 1890s and 1930s; she still managed to become a powerhouse thereafter. And so China will suffer the same hiccups.

China’s ballooning reserves and massive potential borrowing capacity almost assure that any economic crises will be dealt with quickly. In 2008, the Chinese almost immediately spent more than $500 billion dollars to boost her economy as Treasury had to beg Congress to unload more than $750 billion dollars of stimulus to save the banking system. China’s bureaucracy is socialist; but her economic policies are highly pragmatist.

The United States, however, doesn’t have this luxury and must still rely on external debt financing of more than 2 to 3 billion dollars per day to keep its economy functioning. Deficits are soaring, protests are increasing amid social welfare cuts in some states and big government is getting even bigger. This isn’t the Reagan Revolution. It’s the Obama nightmare.

We could sure use a Ronald Reagan right now…

China will continue to grow and will remain the world’s leading consumer of raw materials. She has the economic resources to keep the party going and I suspect this will continue for many years until the United States engages her militarily as the balance of power in this century shifts from West to East. Follow the money trail; it leads to China.

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