The commodities bull trap, part one.

Since the April/May "06, when many commodity prices appeared in a super broad bull cycle I have been arguing here that this is likely to be an investor trap. That as a value investor and rational contrarian (but never a contrarian for just contrarian sake), I have expressed my views here regularly since to avoid the currently fashionable broadly commodities exuberance increasingly prevalent from large hedge funds to housewife investors -around the globe. So far it was wise to step/stay away and stick to our theme of value investing in Thailand’s smaller cap high dividend stocks. Surely some materials are in short supply and prices are rising; however I remain the skeptic as there are likely far more traps then sustained opportunities. China is emerging as a major exporter for many commodities. Not internal insatiable demand, as many wrongly assume.

Here today I introduce the first of a serious of short articles I wish to present to give my own view and so tame what are often outrageous claims by the "nouveau commodity bulls", whom far too often let their enthusiasm be obscured in the proverbial fog, against the hard realities. Here then is my first thought on this theme, with many more to come, for members only.

In many markets China is increasingly becoming a net exporter of commodities not an ever bigger user as so many commodity bulls believe. Take the steel industry as a prominent example, (the same pattern is repeating itself across a range of goods from basic raw materials to manufactured products). China has roughly 260 steelmaking plants with a capacity to roll out steels expected to have reached 400 million tons in 2005 and perhaps as much as 500 millions tons by the end of year 2007. This represents a huge increase in steel production when you consider China produced only some 160 million metric tons in year 2000. Indeed China has shifted from the darling of the international steel market in year 2004, then the largest and fastest growing buyer, to the devil, now a huge low cost exporter competing in other global markets in year 2005.

Or take another example of a big ticket manufactured product. China has built up an impressive auto industry -and domestic market, over the past few years. Its manufacturing capacity is now around 5.5 million cars per year, yet it’s domestic market has risen to only around 2 million cars per year. Clearly excess capacity is designed to meet future domestic demand -but most of it is now being exported.

Or take silver for example, a large amount of silver has been flowing out of China each year since around 1998. The silver mining trade association in North America repeatedly asserted that this silver is being exported from China’s central bank coffers and that since it must have a finite amount of inventories, it would someday soon run out of silver. At that point the price of this metal would skyrocket. So they deduce. In fact, this silver does not come from China’s central bank! But is newly refined metal coming from ongoing sources at smelters and refineries -and from scarp. It will not run out. The silver bulls do not want to hear these protestations and will not give any attention it seems to the rational explanation of what is happening within China. Further much of the silver that used to go into photographic material in China is now exported.

The key point being is that in many ways China’s economic development into the future is turning it into a large supplier of commodities to the world, not just a buyer. Gross miscalculations are regularly reported about Chinese demand for commodities across the board. China’s domestic productive capacity is rising ever further and faster and China increasingly is shifting from being a net importer to being a net exporter of an ever expanding list of both commodities and manufactured products. And since many of these manufactured products are for exports, this merely reflects the shifting of demand from these commodities from other countries, to China for exports, i.e. only a shift of the location of manufacturing, not final demand.

Best Regards to all Members,

Paul A. Renaud.
www.thaistocks.com