HardAssetsInvestor

Written by Brett Owens  |

January 18, 2011

Is China A Leading Indicator For The Commodity Markets?

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All commodity analysts worth their salt recognize China's importance to the marketplace. But just how much of a leading indicator is the Chinese economy anyway?

Most bullish commodity cases offer the seemingly irrefutable argument of "China" as a driver of higher prices in the weeks, months and years ahead. The logic is sound—demand for [Insert Commodity X here] is growing like gangbusters, and this trend will not only continue, but is likely to accelerate as China becomes a net importer for [Commodity X]. This increased demand, coupled with stagnant-to-declining supply for [Commodity X], will give prices a strong tail wind in the months ahead.

Sounds great in theory—but then again, so did communism. So I began to wonder if China's economy was in fact serving as a reliable leading indicator for commodities. In theory, a strong Chinese economy should lead to higher prices for many of its favorite commodities, but an economic setback (like the one we saw in 2008) could send prices on a one-way trade heading south.

Tops In The Shanghai Composite Index

First, let's look at the Chinese economy using my favorite unbiased barometer—the stock market. While GDP and government-reported numbers are easy to distort, you can't beat the charts when it comes to figuring out what is actually going on in a market.

China's Shanghai Composite Index reached its all-time peak in October 2007. It crashed hard in 2008, bottoming near the end of the year (a couple of months before the U.S. stock market bottomed, we should note), and has since rallied to reclaim some of its previous losses:

Source: Google Finance

Quietly, Chinese stocks appear to have topped again—way back in August 2009, in fact—but interestingly, nobody seems to be talking about this.

What Do China Tops—And Bottoms—Mean For Oil?

In hindsight, China's major top in equities in October 2007 was a harbinger of very bad things to come for most asset classes, commodities included. No commodity was left unscathed from the carnage that was to follow.

Some, though, managed to hold on a bit longer—and even rally to blow off previous highs—as Chinese stocks tanked. Crude oil, for example, actually partied an additional nine months before crashing violently from $150 to $35 a barrel:

Source: StockCharts.com