Market Report: Commodity Bull Case Built on Shaky Ground

Oil prices are under a bit of pressure to start the day as attention turns again to the forex markets. Comments from China about their currency and their foreign exchange reserves are capturing the attention of traders across the commodity spectrum. Is it possible that the Chinese are on the verge of letting the Yuan appreciate for the first time since July of 2008?

Market Watch News reported that Chinese central bank Gov. Zhou Xiaochuan said China will in due course move away from its current currency-exchange policy, indicating Beijing doesn't plan to keep the Yuan's de-facto peg to the U.S. dollar indefinitely. These comments, as well as comments surrounding their reserves are giving a boost to the dollar and helping to bring inflated oil back down to earth. Oil prices have been supported by China in many ways and we are just not talking about demand.

China's peg to the dollar, or should we say re-peg to the dollar, has created an excess of printed Yuan's. The Chinese re-pegged their currency to the dollar as the rising Yuan caused China to lose manufacturing jobs as their exports became more expensive. So China went back to its tried and true formula of pegging its currency to the dollar. Chinese's stimulus, along with the dollar peg, has created the perfect scenario for the Chinese to buy more oil driving up the price and doing no favors to the strength of the green back. The Chinese peg is another weight on the dollar making oil more expensive in dollar terms.

Obviously if China lifts its dollar peg this will be bearish for oil, the question is how bearish. Well that depends how much room they give the Yuan to float and when. Gov Xiaochuan says, "Sooner or later, we will exit [these] policies." Of course maybe that means sooner rather than later.

IFAOnline says that China could end its near two-year currency peg on the dollar as soon as next month, according to respected economist Professor Nouriel Roubini. They say that Prof Roubini believes the Beijing government will authorize a 2% increase against the dollar initially, followed by a further 1%-2% strengthening over the next 12 months. "They will move by a token amount. The world is much cloudier in every dimension. They are super cautious."

Also, comments about the Chinese appetite for gold may have an impact on commodities. Market watch reported that China's appetite for gold as a way to diversify its foreign-exchange reserves is limited because of the metal's poor returns over the past 30 years, the nation's foreign-exchange regulator was cited as saying in a report Tuesday. (What, doesn't he believe G. Gordon Liddy?) Marketwatch says that Yi Gang, director of China's State Administration of Foreign Exchange, said China's gold reserve, at 1,054 metric tons, was the fifth-largest in the world, Dow Jones Newswires reported, citing comments by Yi at a press conference at the National People's Congress. But Yi downplayed any desire to add the holdings as a strategy to diversify the nation's $2.4 trillion foreign exchange stockpile. "Gold is not a bad asset, but currently a few factors limit our ability to increase foreign-exchange investment in gold," Yi was quoted as saying. A precursor to another China purchase perhaps?

These types of stories are a reminder how the commodity bull market is built on shaky ground. When you build a base on printed money and central bank currency pegs, we know it creates bubbles that can easily burst.