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Don’t confuse commodities hoarding as a sign of a market turnaround

Unfortunately for investors, prices remain low, and that's driving unforeseen consequences in commodities markets.

Canadian investors did pretty much during the rising tide of commodities prices a decade ago, but they are looking for signs of hope these days. With the S&P/TSX energy index down 20 per cent on the year, and the metals and mining index down by nearly a quarter, they could certainly play one or two.

Maybe investors can easily put their faith within the old adage that the cure for affordable prices is low prices.

What\’s supposed to happen is that low prices will discourage production and encourage consumption. That will raise prices, eventually. Then demand will inevitably wane in response and producers will overdo production, as they always do. Prices will decline again. It is the cycle. Rinse and repeat.

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Unfortunately, we\’re not seeing many signs of the cyclical uptick. Prices remain in the toilet, and that’s driving some unforeseen consequences in commodities markets.

There may be many reasons with this, but a big one is China. To determine how, look no further than the recent performance of the Baltic Dry Index.

Okay, perhaps a little further.

The London-based BDI reflects the cost charged to move stuff – specifically, \”dry\” stuff such as iron ore and corn – across the 23 shipping routes the index tracks. Some have long viewed the BDI as a leading indicator for global trade and economic growth, since it can reflect demand for the recycleables that are accustomed to produce the economic output measured later by trailing indicators like GDP.

The BDI was in the doldrums for much of this year, even hitting a historic lower in February, however the tide has turned.

Since early June, the index has risen by an astonishing 85 percent, approaching levels not seen since last December – prior to the Organization from the Petroleum Exporting Countries put the boots to oil prices by refusing to cut production.

Shipping cost is subject to what the law states of supply and demand. Shipping companies have scrapped a bunch of vessels, which has lowered capacity and supported prices. But that\’s only area of the reason for the BDI\’s rise. Another big part is more shipments to China.

Maybe investors can simply put their faith in the old adage that the cure for low prices is low prices

A sign that the sputtering Chinese industrial engine continues to be given a jump-start? Well, do not get too excited.

For instance, massive imports of corn in June – up from year-ago levels with a factor of 30 – are reportedly one element in the increased shipping activity to China. That\’s because the Chinese government, which tightly controls grain supply and production, is purchasing a whole couple of kernel-y goodness from Ukraine, which was responsible for a lot more than 85 percent of corn imports to China in the first 1 / 2 of the year.

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Why Ukraine? Partly, analysts say, for political and security reasons – specifically, to decrease reliance upon the West. Stability of corn supply is really a political issue in China, mostly since it is used to feed pigs, a major food source.

But what\’s worrisome is the fact that China is buying up corn not to use it, per se, but to stockpile it. According to the U.S. Department of Agriculture, China has by far the world\’s biggest corn reserves at 77 million tons. The government also subsidizes Chinese farmers big-time.

All that purchasing, storing and subsidizing gets expensive, plus some analysts are predicting that China may wish to offload its reserves. Whether it does, which will put further downward pressure on prices.

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