Global Market Commentary

January 12, 2017

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How China Could Boost Commodities

In mid-2014, China’s foreign exchange reserves peaked at nearly $4 trillion.  Since then they have been declining as China defends its targeted exchange rate against the U.S. dollar, and increasingly against a trade-weighted basket of its trading partners’ currencies.  Reserves now stand at slightly more than $3 trillion.

China Spends Down Its Foreign Reserves to Defend the Yuan

Source:  Bloomberg

At some point, the Chinese government’s economic calculus will shift, and it will decide that allowing the yuan to decline further or faster is preferable to a continued bleed of reserves.  

If a lower yuan is becoming visible in China’s future, later in 2017 or in 2018, it the Chinese will be buyers of commodities now before such a currency decline gains momentum.  They need to secure supplies of the commodities essential for fueling their massive and ongoing urbanization — and the continued contentment of their new middle class.  (Remember that one of the Communist Party’s key fears is public discontent, which is why they continue to pursue growth relentlessly, even though they may ultimately create a financial crisis in China because of the means they’re using to pursue it.)

The message in brief?  China’s currency woes could be a boon to global commodities.

Investment implications:  At some point, the Chinese government will decide to scale back its defense of the yuan against the dollar and against the currencies of its other trading partners.  Since 2014, that defense has been costly in terms of draining China’s foreign reserves.  If a weaker yuan becomes visible on the horizon — in late 2017 or in 2018 — that will provide a powerful incentive for China to lock in prices now for the commodities it needs to support its aggressive urbanization program and keep its rising middle class content.  Potential woes for the yuan could be bullish for commodities.