China's Trade Data Continues to Give Mixed Signals

In the background of Wednesday's FOMC obsession was the startling increase in the U.S. deficit with China. While the aggregate real deficit actually declined in June, the deficit with China hit its highest level of the year.  On the surface this development is negative for the dollar and bullish for commodities. On the other hand, China's Imports and Exports dropped for an 11th straight month in June, and U.S. imports of consumer goods fell again in June. The question for investors is which of these two forces will win out.

A widening deficit with China, and with all countries for that matter, increases the likelihood that the Federal Reserve will be required to print the difference. That this expected increase in the supply of dollars is occurring relative to a finite supply of resources has driven commodities prices higher globally. With Oil at $70 a barrel it stands to reason that these capital market risks have been priced into the market. What is therefore needed to drive prices higher is a sustained improvement in demand.

This incremental demand is not going to come from a U.S. economy that is becoming increasingly hostile towards carbon emissions meaning Chinese consumption and that of its BRIC cousins must show a marked turnaround. As it stands, Chinese imports are falling at a time when over $600 Billion has already been pumped into its economy. Even more, inventories of all resources globally continue to stand above long term averages. Lastly, the continued erosion of export markets for Chinese consumer goods belies the price level of commodities.

Even as the short term outlook for commodity demand fails to inspire, the absence of any signs of an abatement of the egregious monetary creation occurring in the U.S. should continue to overwhelm in the near term. As we look further into the future the signs of real economic recovery are appearing everywhere but here and Europe. In China, housing demand has been rising at a 60% clip, and inventory continues to decline. On the back of government subsidies for as far as the eye can see the outlook for development is quickly improving. This type of market shift will be the type of impetus for higher commodities prices that is absent the market currently.

U.S. monetary policy has therefore put a floor under commodities prices which means demand data will have the most influence on prices moving forward. As an investor that means remaining patient with resource positions (NYSE: IYM) and (NYSE: OIH) and buying corrections. Investors may consider concentrating on resource names paying dividends as you wait for demand to recover or selling calls against long positions.  

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