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The Commodity Bloodbath Worsens as Downward Pressure Persists in China

The Commodity Bloodbath Worsens as Downward Pressure Persists in China

James Stanley, Senior Strategist

- Chinese trade data disappointed again, with imports falling for the 13th consecutive month and exports falling for the 5th consecutive month as the slowdown in the world’s second largest national economy continues to worsen. This is on the heels of an abysmal trade data report out of China last month.

- This continued softening in Chinese data raises the question as to whether global stimulus measures have ‘worked’ or whether they’re just delaying (and making worse) the inevitable.

- Three weeks ago, President Xi warned the world that China faces considerable downward pressure, but Global stocks have continued to move up like it’s 2009. Will stock prices continue to trade higher until, eventually, the data turns around? Or will stock prices come down to reflect these heightened concerns?

- Commodity prices continue to get smashed, and this will likely have negative impacts for corporate earnings going into next year, and this could be the linchpin that finally brings stock prices down (more likely at some point next year after the Fed hikes).

Even more bad Chinese Data: Last night gave us yet another piece of troubling data out of Chinese, and this was yet another massive decline in trade numbers. Chinese exports, which is a huge driver of growth in the still-industrialized economy, fell for the 5th consecutive month, falling by -6.8%. While this was slightly more shallow than the -6.9% contraction to exports in the prior month, it was still considerably beyond the -5% expectation that many analysts were looking for, and this further highlights the fact of growing pressure in the world’s second largest national economy.

Unfortunately, this drop to exports wasn’t the only data point to come out negatively last night, as imports also disappointed, and this was the 13th consecutive month for Chinese imports to fall. Last month saw a -8.7% contraction after an outsized loss in the month prior, and this is troubling on a couple of different fronts. Near-term, this presents challenges for China’s trade partners, namely Japan, Australia, New Zealand and the United States. But bigger picture, this is perhaps even more troubling for the long-term growth prospects of China. One of the big drives in the Chinese economy is to become less reliant on exports by growing their consumer segment. A greater than -25% contraction to imports over the past two months not only increases the pain for their trade partners (this is yet another challenge for the Bank of Japan to counter while they’re already battling deflation), but indicates that China’s consumer segment may not grow (or may not have grown) as quickly as the government would’ve liked.

In response, the Yuan was fixed significantly lower last night, and again, this is troubling for China’s trade partners, particularly Japan in this case, as an already weakened Japanese economy can ill-afford a competitive disadvantage with their biggest trading partner. The very act of the Yuan weakening makes Chinese exports more competitive overseas, so this speaks directly to the recent decline in Chinese trade data. With a weaker Yuan, it will be more accommodating for China to reverse these trends in both imports and exports; but it spells trouble for economies like Japan or the US where, by deduction, those currencies will get more expensive as the Yuan weakens off even more. This will make US and Japanese goods less competitive, and this will hinder long-term profit growth. On the chart below, we’re looking at USD/CNH, and you can notice how we’re trading at the highest level in the pair (which indicates weakness in the Yuan), since the Chinese market meltdown in September.

The Commodity Bloodbath Worsens as Downward Pressure Persists in China

Created with Marketscope/Trading Station II; prepared by James Stanley

This is a troubling trend, yet stock prices are continuing to go up. We discussed the previous trade balance numbers out of China in the article, More Slowdown Signs, and we went deep down the rabbit hole last week after Chinese PMI printed at its lowest level since 2012.

But because stock prices have continued to go up, much of the financial media and a large portion of the financial world seem to think that everything is just going to continue moving higher, and the big reason has been the continued willingness of Central Bankers and politicians around-the-world to continue stimulating markets in the hope that their corresponding economies will turn around. This has helped to spark hope in China, and we discussed that theme as it began in the article, Don’t Call it a Comeback: Small-Cap Chinese Stocks Throttle Higher, and we continued on that topic a month later in the article, Is There a New Bull in the China Shop?

To be sure, this isn’t relegated to China, the whole ‘bad data is good,’ theme. This started in the United States with the continued onslaught of QE in which worsening or negative data meant even more support from the Fed. And it hasn’t collapsed, yet, leading many to believe that asset prices will just continue ascending forever.

But there are troubling prospects shifting beneath our feet that make the idea of constantly ascending stock prices an unrealistic probability. We’re beginning to see the consequences of ZIRP rear its ugly head, and this will likely have profound repercussions. We saw one such repercussion last week, when the Japanese Government Pension Investment Fund (GPIF) reported a $64 Billion drawdown of ~-5.5%. With yields so incredibly low and with QE in Japan having already monetized every bond that the economy prints, the Pension fund was looking for higher returns and allocated 50% of their holdings into stocks (half international, half domestic). After six years of ZIRP and massive bull markets, this prospect looked significantly more attractive when the measure was announced in Halloween of 2014. But as volatility has throttled back up and as those international stock investments have faced turbulence, Japanese pensioners were forced to take a greater than 5% loss over August and September. This also may hamper future BOJ motivation to increase or extend QE, considering that they just saw two full months’ worth of purchases wiped away in a single market swing.

Longer-term, China has some very big problems ahead that aren’t too dissimilar from Japan. This is a sociological issue that comes with an aging population, and despite any government intervention efforts or stimulus programs, this is basically a math problem that the world is going to have a hard time beating, but that’s a matter for another day (or for the next 45 years). We discussed this in the article, China as Japan 2.0.

Of relevance for current price action, traders that want to jump on this theme should look to Japan. While China will steal the headlines, it’s Japan that will feel the most pain. A slowdown in China is troubling for Japan because that means that they will sell fewer goods in their primary trade partner’s economy. And for an economy that’s already facing deflation (Japan), with a Central Bank that is already stretched (Japan’s Debt-to-GDP is greater than 250%!) and for a Central Bank that just took a $64 Billion hit based on stock investments – Japan is very, very vulnerable. Last week, we highlighted the Nikkei and we showed you the resistance that’s shown up at the 20k level. Thus far, prices have reacted lower by approximately -3.25% and we’ve just run into a key support level. But this thing can fall significantly further, and the lows from September at 16,890 could be a very valid profit target for longer-term positions.

The Commodity Bloodbath Worsens as Downward Pressure Persists in China

Created with Marketscope/Trading Station II; prepared by James Stanley

Commodities are falling faster than…. You can pretty much insert any heavily-weighted object to fill in this aphorism, but the pain in commodities is continuing to pick up, and this is another theme that we’ve been warning of over the past few months. But not just because of the near-term impact of these falling commodity prices, but what they might be telling us about the trajectory of the global economy. We discussed this theme at length a few weeks ago in the article, What Might Copper Prices Be Telling Us About Global Growth? For such an industrialized commodity like Copper, a dramatic drop in prices sounds the alarm bells for global growth. But the pain hasn’t been relegated to Copper, Gold is in the midst of a jaw-dropping run, as are Oil prices.

Of particular interest to the US economy is the precipitous drop in Oil prices. As low rates drove investment in the US over the past six years, many breakthroughs have been seen in energy extraction. This drove energy prices higher, and that further incentivized other entrepreneurs to go out, get a loan, and try to extract some energy from the earth so that they could sell it to the open market. This is profit incentive, and as long as commodity prices are continuing higher, everything is beautiful.

But eventually, this profit incentive reaches an apex in which the market can no longer absorb higher prices as supplies continue to add up. This is when prices start falling, and continue falling until demand offsets supply at this lower price point. Maybe it’s at $30, maybe $20 or maybe even $15, nobody really knows. That is where we’re at now, prices are falling and we don’t know how low they will go. But what we do know is that all of those entrepreneurs that went out and got loans to extract energy (which was essentially just a carry trade, borrowing while rates were low, investing in commodities) are facing increasing amounts of pain as not only are oil prices dropping, but interest rates are about to go up. This is a double-whammy of pain that’s going to further erode profit margins (if there are any left) to the point of unprofitability.

This is why Oil may now be carrying a leading indication for the US economy, and this is another reason that 2016 isn’t looking to be very bullish; at least not to the degree of the past six years. We discussed this premise in the article, Apple, Oil to Cue Global Markets, and with fresh declines being seen in Oil, the next few months will show us how much pain was taken on the back of these price moves. As US companies report earnings over the coming quarters, we’ll see how negatively this dip in energy prices has impacted business operations.

For now, Oil prices are falling faster than a rock (or any other heavily-weighted object), and this is a market that you don’t want to be long of. For energy producers in the United States that have already taken out loans and started their drilling operations, they aren’t so lucky. They’re long and the only way that they can square up the position is by waving the white flag and declaring ‘game over.’ But for traders, a close is a simple click away, at which point you can flip to the short side whenever you might want.

You might not want to do so now since we’re sitting at lows; but if that whole ‘feel good, the Fed has got this’ theme comes back into markets, there may be an opportunity to sell this at a higher price, exactly as we were able to do with Gold over the past couple of weeks. Gold Aggressive Short Setup Available and Gold: Short Setup Available off of a Key Fibonacci Level.

The Commodity Bloodbath Worsens as Downward Pressure Persists in China

Created with Marketscope/Trading Station II; prepared by James Stanley

--- Written by James Stanley, Analyst for DailyFX.com

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