The other day I received an email asking if I knew what was ailing copper. Usually copper and oil follow each other fairly closely. They are both economically sensitive, so their correlation is fairly high.
Yet over the past month, crude oil has rallied while copper has quietly slipped to new lows for the year.
I have seen many different attempts at explaining this divergence. Most seemed like stabs in the dark when the answer should really be “no idea” and a shrug of the shoulders.
I am going to throw out a theory. It might be a little bit of a stretch, but I think it is worth considering.
The new bull market in commodities
Over the path decade and a half, industrial metals like copper exploded upwards due to the massive infrastructure and housing build out in China. Never before has there been such an intense demand for these commodities.
This is an older chart, but the amount of copper used per unit of GDP has been off the chart for China:
Yet this is an old story.
The Chinese government has realized the recent manic growth has to shift. So over the past couple of years, they have put in place policies to curb down infrastructure and housing growth, and instead transition to a more balanced economy.
Given these policies it makes sense copper might not be as well bid. The Chinese are no longer going to buy endless amounts of these same commodities.
But what the market is missing is that China is not a one trick pony. It’s not “grow through infrastructure spending” or die. Their consumers are in the process of moving up the food chain. They have become wealthier, and are beginning to spend money on items that we have taken for granted in developed markets.
One of those items is automobiles. Chinese car purchases has tripled since 2008.
Although I understand that electric cars will be encouraged in China, they will still sell boatloads of the regular old gasoline kind. As much as the Bill Nye’s of the world want carbon based fossil fuels outlawed, it ain’t going to happen. Especially in China.
As China’s wealth grows (albeit at a slower pace) and the consumer becomes more able to afford these sort of luxuries, the demand for certain commodities will surprise market analysts. A decade ago most analysts under appreciated the vast demand for infrastructure based commodities. By the end of the cycle, they of course believed demand would continue forever. When that didn’t happen, they became despondent about the future of all commodities.
But once again, they are underestimating the demand for the new commodities.
Items that the growing middle class of Chinese consumers want will go up in price. A lot. Oil will be one of those commodities. Most analysts are focused on the dreary looking supply side of the equation. In the coming years, the demand side will surprise them. And it will be mainly because of China.
I am bullish on grains for a variety of reasons, but I know just enough to get myself in trouble. Soybeans have surprised me by outperforming both wheat and corn by a large stretch. Surprising strong Chinese demand for soybean meal seems to be number one reason cited for this divergence.
Guess how they use soybean meal? Feeding it to pigs. As the Chinese consumer has become wealthier, they can afford more pork. This means more pigs, which means more demand for soybean meal.
There is a new bull market coming in commodities. The big rises just won’t occur in the same commodities as the last bull market. Make sure you buy things that the increasingly wealthier Chinese consumers are going to buy, and not the commodities that went up the most last time…
Thanks for reading,