Monday, April 15th, 2013

Fundamentals are less important than you think

Gloom and doom today. The flash estimate for Chinese first quarter GDP has come in slightly below forecast and all commodities have fallen sharply. Gold is down 7% on the day; crude oil and copper are both down 3%. This looks like a simple case of cause and effect, with lots of easy headlines for market reporters everywhere. What a shame that the story doesn’t really stack up.

The link between weak Chinese GDP and the falling copper price is not controversial, especially if you believe that the apparent demand numbers have been inflated by local companies pledging copper stocks as collateral for financing. But the links with gold and with crude oil are much less clear cut. Yes, China is the second largest user of oil, but its share of global consumption is still less than 10%, in contrast to the 20% or more for industrial commodities such as iron ore and copper. Yes, slower Chinese GDP should translate into lower global inflation, all other things being equal, but the scale of the miss and the scale of the market reaction are wildly disproportionate. There is no way that a miss of 0.3% in GDP forecasts translates into a 7% fall in the gold price. So what is going on?

Regular readers of this blog will be aware that we have been concerned about the outlook for commodities for some time. Our previous note (Di-worse-ification 25/03/2013) made the point that all aspects of commodity exposure were profoundly unattractive. The asset class was the least attractive of all the major asset classes (equities, bonds, real estate etc.), the sector was a clear underweight in every regional equity index, and countries with high commodity exports were nearly all in the bottom quartile of a country ranking which includes 44 developed and emerging equity markets.

What we see in today’s price reaction is the cumulative effect of some very poor risk-adjusted returns over the last two years. One never knows when this sort of reaction (the revulsion reflex) is going to happen, but it isn’t the result of one set of GDP numbers, which in any case are not seasonally-adjusted (this being China). Sometimes fundamental data are less important and less informative than the raw ebb and flow of prices and returns.

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