Today's comment is by Eric Roseman, Investment Director for The Sovereign Society and Editor of Commodity Trend Alert.
Dear A-Letter Reader:
China's surprise interest rate hike last week was more symbolic than anything else. Any major correction for commodities should be viewed as an excellent buying opportunity for long-term investors as China ultimately makes her currency convertible and becomes the world's largest economy over the next twenty years or sooner.
The hike was the first since late 2004 and shocked the markets, causing a one-day plunge in commodities and sending Asian bourses sharply lower. The main fears are that The Bank of China may curtail domestic lending to cool its booming economy. But those fears are exaggerated.
Over the last two years, China has vowed to slow its runaway economy. China's economy is now the envy of the world, following a torrid 10.2% first quarter GDP growth rate. In 2004, when The Bank of China first publicly announced its intentions to slow growth, the economy was clocking a 9.5% growth rate. Statistics for the first quarter showed bank lending is rampant, already half of the government's 2006 target of $312.5 billion dollars.
The Bank of China raised interest rates on April 27th to 5.85% from 5.58%, making it slightly more expensive for companies to borrow. In reality, however, China can ill-afford a slowing economy.
Home to 1.3 billion people, China's labor market has mushroomed this decade. And the transition from rural employment to higher-paying manufacturing jobs has accelerated at the same time. This is especially true in the Special Economic Zones, which have drawn millions of workers yearning for a slice of the great Chinese growth story.
Yet China, in many ways, resembles the U.S. at this stage of the interest rate cycle. Both countries are ratcheting short-term rates higher to cool above-average growth rates. But both central banks need to be careful. If they raise rates too rapidly, it could destroy their expansions and adversely impact the global economy at the same time.
For the U.S., sharply higher rates would capsize a heavily leveraged economy, dependent on consumer spending and foreign borrowing. America also relies on inflated real estate equity to fund her consumption, as second mortgages, home equity lines of credit and even reverse mortgages have ballooned since 2003.
In China, a dramatic economic slowdown would result in a few hundred million people being displaced as manufacturing would suffer. That's why both central banks won't raise interest rates much higher from current levels. The U.S. can't handle high rates while the hawkish monetary policy in China would create millions of unemployed.
The commodity bull market since 2002 has largely been predicated on China's insatiable appetite for virtually every conceivable raw material to feed her booming expansion. Combined with the lowest inventories in history for base metals and precious metals (most are already in supply deficit in 2006) and declining global oil production, the commodity bull market remains alive and well. Don't fear an economic slowdown in China - commodities will continue to rise this decade as global growth continues and global liquidity remains buoyant.
ERIC ROSEMAN, Investment Director
on behalf of The Sovereign Society