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Inventory Tug-of-War: Destockers vs. Restockers

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Endless back-and-forth sign of an atypical recovery.

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The concern I have is that over the past few months, numerous commodity producers have announced plans to curtail or shut in production. Industries such as ferrous and non-ferrous metals, natural gas, potash and even most recently (gasp) coal, finally came to grips with reality and turned off the spigot. Therefore, commodity prices we're seeing in the marketplace are not so much based on increasing demand with constant or dwindling supply as much as they're based on what currency they're priced in, and more importantly, supply diminishing at a greater rate than that of demand.

The resulting price action has lead some to conclude that rising prices are foretelling of world economic growth getting back on track. Copper is a good example of this. Yes, I know this is Economics 101. What isn't Economics 101 is what's led to the global consumption contraction, and what happens after any temporary blips in demand for inventory run their course. Perhaps Socioeconomics 101 would be a better course for that lesson.

You can see this already starting to happen by reading the end of the ISM comment posted above regarding copper. Beware the song of the sirens.

As you know, I feel the recovery will be atypical, and this back-and-forth tug-of-war is a good example of the type of economic chop we're in store for; fits and starts represented by the blade of the hockey stick.

Over the last 2 months, Chinese economic activity has been sparked by internal stimulus, government stockpiling as well as Chinese industrial producers' restocking their own raw-material inventories. The more reliable CLSA economic numbers also confirm such. Chinese manufacturers aren't ignorant to economics, and they're rebuilding these inventories from companies such as RIO, Rio Tinto (RTP) and Billiton (BHP) at substantially discounted rates (20-50% y/y discounts). In fact, at a conference in Beijing on April 28, a China Ministry of Industry Official, Jia Yinsong, said China's iron ore imports in March exceeded demand, which led to port congestion. So while inventories are being replenished, it's occurring at substantially cheaper prices. Sound familiar?

Take a look at the bases that have formed -- and in some instances experienced breakouts -- in numerous commodities such as copper, coal, lumber, aluminum, zinc, nickel etc. I'm referencing GSCI spot for the industrial metals. Some have broken out of their supply-constrained bases while others are still trading within them. The reason for each commodity's respective action is what's important to remember.

If certain oil-producing nations weren't so desperate to sell oil to meet their domestic obligations (e.g. certain Latin American countries and Russia) I suspect you'd be seeing oil prices tracing out a similar pattern as the aforementioned commodities. In fact, it still might.
No positions in stocks mentioned.
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