Investors aren’t limited to only investing in the S&P 500 and the Dow Jones Industrial Average. Every week we share the market trends we are following. We are interested in whether the trends in those markets are continuing or if they are experiencing a temporary or complete reversal.
When we identify trends, we are only concerned about the price data and what it says about any given market. We don’t need to know why a trend has formed to invest, but our human nature wants to understand what is driving them. Each week we try to offer some perspective on what we think the most substantial moves are and what critical drivers are behind them. Here we look at what is going in our globally diversified, non-correlated Crystal Bay Ubitrend strategy.
Last week’s continuing trends:
- Lumber
- Euro-Pound Cross
- Silver
- Feeder Cattle
- Indian Rupee
Last week’s reversing trends:
- Oats
- Cotton
- Hong Kong H-Shares
- Nickel
- Coffee
What we are taking note of:
As US investors’ focus remains fixed firmly on the Fed, there is a continuing tectonic shift in the world economy. It seems trite to invoke the rise of China as the most important facet of the 21st century, but Chinese economic dominance is accelerating, and its repercussions are not fully visible yet. The US is no longer the world’s largest economy; China overtook it four years ago. There is a misunderstanding about this: at market exchange rates, China is still smaller than the US, but at purchasing power parity, it has grown bigger.
I’ll illustrate the difference between market prices and purchasing power parity from my personal experience. A bagel with cream cheese in Menlo Park, Calif. costs 40% more than the same bagel in Pleasanton, just 45 minutes’ drive away. The bagels are made by the same franchise chain; they taste the same; there is absolutely no difference between them. Why the price discrepancy? On the one hand, costs in Pleasanton are lower: rents and wages on the outer edges of the Bay Area are less insane than in the middle of Silicon Valley.
On the other hand, Menlo Park customers are not price sensitive and don’t care about a dollar here, a dollar there, so charging them more is easy. At market prices, the bagel store in Menlo Park generates 40% more revenues than the Pleasanton store. However, if we compare the stores bagel to bagel (at purchasing power parity), they produce about the same amount of bagels daily. Would anyone say that the Menlo Park store is 40% bigger than the Pleasanton store? That would be absurd. Yet that’s how GDP at market prices works.
Purchasing power parity corrects pricing and exchange rate differentials and measures the actual production of goods in a country. That is more useful for some purposes (like comparing living standards) and less useful for others (like evaluating the ratio of foreign reserves to GDP). As commodity investors, we’re interested in the physical production and consumption of commodities, and that’s where purchasing power parity serves as a better guide to the importance of the Chinese market.
Chinese GDP took a hit in the first quarter on COVID shutdowns like everybody else. Together with the rest of Asia, the country handled the pandemic much better than the rest of the world. In the second quarter, China reported that it not only made up for the lost production but actually grew its GDP year over year. That may seem incredible when viewed from the US, where Q2 GDP is on track to decline by 35%. Chinese government statistics leave much doubt about their accuracy, but alternative data point to a real economic recovery: electricity consumption, traffic volumes, and even pollution are coming back to pre-COVID levels.
The relative importance of China to the world economy is going to increase in 2020 as a result. China was already #1 going into the year, and it will come out with an even bigger lead. For commodity investing, this has important implications. China’s commodity basket is different from that of the Western countries. Oil and energy are not as important for China as for Western countries, while base metals play a much bigger role due to their use in infrastructure buildout. China represents more than half of total world consumption of Copper and Iron Ore, as well as Tin, Nickel, and Zinc.
How are we heading into next week?
We have seen a wide divergence in performance between China-sensitive commodities and the rest. While Oil languishes at $40 per barrel, Iron Ore, Nickel, and Copper are seeing accelerating trends in price. New Zealand dollar is strengthening, benefiting from the country’s reliance on the Chinese market for its dairy and meat exports. Cotton is also recovering strongly.
US investors have very little exposure to China. They will not benefit from its recovery by investing in Nasdaq or S&P 500, government bonds, or domestic real estate, the usual cornerstones of asset allocation. As a class, they take an implicit bet against China.
The Crystal Bay Ubitrend has a growing number of positions with exposure to strong Chinese economic growth, including Cotton, Copper, Nickel, and the New Zealand Dollar, as well as Iron Ore.
Iron Ore – Year to Date
