Chinese torture is holding back the commodities rally

CHINA was once famous for, among other things, an obscure torture method: reputedly a way to drive suspects insane by slowly dripping water onto their foreheads. Nowadays, however, many commodities traders must feel rather like victims of the technique. The Chinese government has been slowly drip-feeding the commodities markets with hints about monetary tightening.

On Friday, the People’s Bank of China (PBoC) raised its reserve requirements for the fourth time in two months in an attempt to slow high inflation. Mining and commodity stocks fell back heavily on the news, with coal miner Xstrata losing 1.65 per cent and Antofagasta losing 2.4 per cent.

The logic is that slower growth in the Chinese economy would reduce the demand for industrial commodities such as copper, in turn hitting the profitability of the firms that produce them. But relatively few commodities analysts believe that the Chinese are tightening nearly fast enough to take the wind out of rising commodity prices. Is this perhaps a reasonable opportunity for spread betters to go long?

Manoj Ladwa, senior trader at ETX Capital, thinks not. “Anything commodity related is progressively grinding lower” he says, and that is likely to carry on next week. “There’s been a little bout of selling, and I’m inclined to believe that it will continue”, at least for a little while.

Alastair McCaig, markets analyst at World Spreads, agrees. He points to gold miners as being particularly vulnerable at the moment. “Gold, and all precious metals really, are viewed as safe havens, but there’s been a string of news recently that’s quite positive – not euphoric, but enough for people to think there’s cash out there and act a little more optimistic”.

As a result, the demand for precious metals and other commodities as a hedge against inflation has been dropping away, and the shares of miners such as Randgold Resources have followed. Though there may yet be some “little panic flurries”, McCaig believes that precious metals miners in particular will continue to lose ground.

He also warns investors to watch individual stocks too, however. The flooding in Australia has threatened to slow production for some miners, such as Xstrata, though few details have been confirmed. Traders might be well advised to steer clear of companies with heavy Australian operations, while buying into those likely to benefit from any supply squeeze.

Ultimately, commodities stocks have performed well consistently for much of the last year. The momentum might now have faltered, but with the spot prices of underlying industrial metals likely to keep rising, traders would seem well advised to expect a rebound eventually. The important thing is to profit from volatility in the meantime. For traders aiming to do that, the Chinese water torture of slow, drip-fed information ought to be something of a blessing.