China and commodity prices
January 21, 2005

China’s demand for raw materials has had a significant impact on metal prices. Its demand for ores and metals has increased fifteen-fold since 1990, and as China continues to urbanize its population and modernize its economy, its demand for raw materials is likely to increase by orders of magnitude.

The economic ascent of China is probably the single most important economic event of the twenty-first century. Within twenty years China could surpass Japan to become the second largest economy and before the end of the century it will most likely be the largest economy in the world.

Even though Chinese demand will continue to drive commodity prices higher for the next fifty to a hundred years, my own investment horizon does not stretch that far. And I am concerned that in the short-term, the current bull market in commodities has come to an end.

Before we go any further, let me state for the record that gold is not a commodity. It is money. So when I am referring to commodity prices I am explicitly not including gold. Metal commodities are things like copper, zinc and lead.

My concern for the commodities bull market hinges on the fact that I believe the US economy is in trouble. If the US is heading for a recession, and US consumer demand wanes as a result, it will most certainly impact the Chinese economy, which will impact China’s demand for commodities, and that could cause commodity prices to drop.

The Chinese economy is not yet ready to sustain its own economic growth. Much of the economic growth in China has been due to increased trade between China and the rest of the world. China’s gross domestic product increased three-fold from 1990 to 2003, but its trade volume grew seven-fold during that time. China’s trade, as a percentage of gross domestic product, increased from thirty-two percent in 1990 to sixty-five percent in 2003. Therefore, a decline in trade will significantly impact China’s gross domestic product, and a downturn in China’s economic activity will reduce its demand for raw materials.

China is particularly sensitive to US demand. US imports of Chinese goods increased eight-fold from 1990 to 2002 and now account for roughly forty percent of all goods exported from China.

So, if the US’s spending spree is over, as I suspect it is, then China’s economic expansion could take a breather, and that could lead to a decline in commodity prices. One exception is uranium, but that’s another story.

Paul van Eeden

PS I will be in Vancouver this weekend speaking at the Cambridge House investment conference (www.cambridgehouse.ca) and at the Cordilleran Roundup (a mineral exploration conference) the following week, so there will not be a commentary next week.

Paul van Eeden works primarily to find investments for his own portfolio and shares his investment ideas with subscribers to his weekly investment publication. For more information please visit his website (www.paulvaneeden.com) or contact his publisher at (800) 528-0559 or (602) 252-4477.

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