While investor attention turned to the bloodletting in the stock market this week, there appear to be opportunities quietly arising in the commodities markets as a result of this week's activity.
US equities dropped sharply from the one-two punch of a slide in the Chinese markets combined with investor fears that the US economy could be headed for recession.
While some traders may site US recession fears as the key reason for the decline, we are of the opinion that the China issue was, and continues to be, the catalyst for this weeks slide in stocks. The Chinese have been desperate to find a way to cool their rapidly expanding economy and curb wild speculation by its citizens in the Chinese stock market. The Chinese government indicated that it may now begin a series of steps to limit economic expansion and speculation. These could include raising interest rates, reducing funds available for lending, taxing capital gains or limiting foreign investments.
Investors are betting that these steps could very well slow the Chinese economy or investment in the region. As a result, Chinese stocks collapsed 9% on Tuesday, setting off a chain reaction of market declines throughout the world.
But what is causing pain to many stock investors may very well have created some opportunities for commodities investors. In our commentary last month, we outlined a case for selling calls in the copper market in the first quarter of 2007. In our view, this new development only adds to the case for selling far out of the money calls in copper. If the Chinese economy does indeed begin to slow, expect copper prices to continue to slide in 2007. China is one of the worlds top consumers of copper and a slowdown will deal a considerable blow to demandâthis in addition to the already bearish fundamentals currently affecting copper (see Commodities Roundup: Copper, 2/9/07).
In last week's Commodities Roundup, we outlined a strategy of selling puts in the gold market should prices decline. While we didn't expect such a sudden decline in prices, we feel that the longer term picture still remains fairly bright for gold and that the sell off is creating an opportunity.
The Gold and Silver markets recoiled sharply as a result of this week's developments, largely as a result of fund and speculator liquidation. A slowing Chinese and possibly US economy mean less demand for goods and services and therefore, a lower threat of inflation. As Gold and Silver are seen as key hedges against inflation, speculators (who were heavily long the market) headed for the doors when the China news hit. We think precious metals were also sharply overbought which has exaggerated the selling this week. Yet, investment interest in precious metals remains keen and if global stock markets continue to decline or, at least produce anxiety, gold will eventually return to its status as a safe haven.
James Cordier & Michael Gross
Contributing Writers, Liberty Trading Group
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