21.01.2019 (seekingalpha.com) -  

 Summary

• ·         China's economic fortunes are set to improve in 2019.

• ·         Trade tariff dispute between U.S. and China will likely also resolve.

• ·         An improving China outlook bodes well for higher commodity prices.

Could a revival of China's financial market and manufacturing sector prospects in 2019 stimulate higher prices for commodities? That's what many commodity traders are banking on, and there are reasons to support this optimistic outlook. In today's report, we'll examine the exciting developments which point to a China rebound in the coming months. I'll make the case here that a strengthening of China's economy will, in turn, lift consumption of several key commodities.

One of the major reasons why commodity prices took a hit in the latter part of 2018 was because of the threat of a slowdown in China's manufacturing sector. The additional psychological chill brought about by the U.S.-China trade tariff dispute made things worse as commodities demand from the world's second biggest economy was seen diminishing. After entering a bear market in 2018, China's Shanghai Composite Index (below) only exacerbated fears among China watchers that its economy was headed for trouble. China's stock market woes also increased worries among investors over a potential spillover into the U.S. market.

The result of these fears was a sharp slide in commodity prices beginning last May and continuing through the end of the year. Accompanying the weakness in hard asset prices was a strengthening dollar. Investors were sufficiently scared over the global economic outlook to turn to the U.S. dollar as a safe haven. A rising dollar index put additional downside pressure on commodity prices, creating what almost amounted to a death spiral for some assets. Shown here is the Invesco DB U.S. Dollar Index Bullish Fund (UUP) which highlights the magnitude of the dollar's rally last year.

Among the biggest casualties of last year's China weakness was the crude oil price. After hitting a high of $75/barrel, the oil price fell to $42/barrel in just a 3-month period starting in October. Oil's plunge even sparked fears that deflationary pressures were reviving in the global economy, which sent a collective shudder down investors' spines and resulted in an equity market sell-off.

But just when it looked like things could only get worse, the situation changed for the better. Stock prices around the world hit bottom in the final weeks of 2018, while commodity prices also bottomed at year's end. The catalyst for the bottom was the evident belief among informed investors that 2019 would witness an improvement in U.S.-China trade relations.

The belief that 2019 will witness an improvement in global stocks and commodities is reflected in a number of key indicators, including China's own yuan currency. Shown here is the WisdomTree Chinese Yuan Strategy Fund (CYB), my favorite yen proxy, which has been bottoming for the last five months. The yen ETF even made a higher peak this month in reflection of the strengthening of China's currency. To quote Scott Grannis of the Calafia Beach Pundit blog:

The recent upturn in the value of the yuan likely reflects the market's belief that a resolution to the U.S.-China Trade War could be in the offing."

There is no better indication of China's overall strength than the relative stability of its currency. Any additional improvement in the yuan from here can only benefit the global economy, and by extension, the demand for industrial commodities.

ueling the market's belief that a trade resolution is near is a recent report indicating that U.S. Treasury Secretary Steven Mnuchin advocates the lifting of tariffs on Chinese imports. Investors greeted the rumor with enthusiasm late last week as a strong rally in both stocks and commodities followed. Regardless of whether or not there is any substance behind the rumor, there is growing evidence that the outlook for China is indeed improving.

More than just the prospects for a stronger China in the coming months, the emerging markets are also showing signs of being on the mend. Shown below is the iShares MSCI Emerging Markets ETF (EEM). Historically, there has been a close correlation between emerging market stocks and commodity prices. The equity prices of the world's biggest EM countries reflect the strength or weakness of those economies, many of which are heavily reliant on commodity exports and industrial consumption of feedstock commodities.

Note that the EEM graph shown above suggests a bottoming process has been underway since October. A breakout to a higher high above the 42.00 level in EEM would technically confirm a new short-term upward trend has been established. This, in turn, would lend at least some residual support to the nascent commodity price recovery.

Aside from improving technical and fundamental factors, there have been a number of news headlines of late which suggest a benign intermediate-term outlook for hard assets. In what amounts to a welcome development for natural resource bulls, analysts and Goldman Sachs have expressed a bullish outlook for commodities. Jeff Currie, head of Goldman's commodities research, stated that the investment bank is now bullish on crude oil and gold in particular for 2019 after a more tempered outlook in 2018. Currie said the bank's positive bias is based, among other factors, on an improved U.S. interest rate outlook and a weaker dollar.

Bullish sentiment from Goldman has often been supportive of asset prices in the past. This is because of Goldman's widely respected reputation and the weight its forecasts have historically carried among serious investors. What's more, the fact that Goldman has historically been an agenda setter for commodity prices is another reason why its latest prediction can't be lightly dismissed. Indeed, Goldman's latest pronouncement on the commodities outlook amounts to an advertisement for the natural resource sector. Asset managers will now be looking more closely at the beaten-down commodities like crude oil and the grains complex.

Another key development which strongly supports a commodity market rebound in the coming months is the latest action taken by China's central bank. On Jan. 16, China's central bank injected the equivalent of US$83 billion into its banking system in a clear sign the government stands ready to do "whatever it takes" to revive its beleaguered manufacturing sector. Incidentally, this was the biggest ever 1-day liquidity injection on record for China. A central bank-inspired rebound in China's manufacturing economy can only help lift commodity prices.

One of the charts which investors should be closely monitoring in the coming weeks is the Thomson Reuters/CoreCommodity CRB Index (CRB). The CRB is the benchmark for the broad commodity prices outlook in the U.S. and it suggests that a reversal of the late 2018 plunge has begun. After closing two days higher above the 15-day moving average to confirm an immediate-term bottom (per the rules of my trading discipline), the CRB price has established a series of higher highs and lows. This is the basic definition of a rising trend, and with the fundamental factors now in place for increasing demand for raw materials, the next few months should witness a benign climate for commodity investors.

One of the commodities which should experience the biggest rebound in 2019 is crude oil. The plunge in crude prices in late 2018 was based to a large extent on China-related fears. The latest action taken by China's central bank, coupled with recent improvements in the yuan, imply that these fears will be quickly erased in the early part of this year. For that reason, the huge losses suffered in the crude oil market should also be erased. Moreover, anything that benefits the oil price will ultimately benefit the broad commodity market.

In light of these considerations, investors can lean bullish on the natural resource sector as we head further into 2019. My personal favorites for showing continued strength this year include gold, oil, and sugar, as discussed in previous reports.

Disclosure: I am/we are long SPHQ, IAU, CANE. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

https://seekingalpha.com/article/4234547-china-rebound-will-lift-commodity-prices