So much for the great commodities crash.
After last week's big panic, commodities have stabilised and rebounded rapidly. Even silver is off its lows.
The positive news on US jobs on Friday helped, as the fear that the US economy can't support itself without a steady stream of printed money ebbed somewhat.
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Most pundits have decided that the main reason prices plunged last week is that 'it was time for a sell-off'.
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So is it time to pile back in?
The bullish case for commodities is common knowledge
The bullish case for commodities is based on a number of things, but the main one is the rapid development of the emerging economies. We first started writing about the wealth shift from West to East in MoneyWeek magazine many years ago.
"The rise of China" tale didn't really enter mainstream consciousness until just before the credit crisis of 2008, oddly enough. However, that story is well known now. As is the notion of 'peak oil' the idea that we are close to, or already past, the point where we're getting as much oil out of the ground as we're ever going to get.
That's not to say that these arguments aren't still valid. But once a story becomes received wisdom, it's worth having a look at the counter-arguments. Because most of the time, when everyone starts expecting things to go one way, the market has a habit of pulling the rug out from under them.
First off, there's China. A slowdown in the country is the most widely-acknowledged threat to the commodities bull market. And the latest inflation figures do little to dispel that concern.
China's official consumer price inflation rate came in at 5.3% in April. That's down from 5.4% in March, but more than the 5.2% expected. It's also well above China's target rate of 4% a year, for the fourth month in a row.
It's hard to overstate how concerned China is about inflation. Just look at the recent example of consumer goods giant Unilever. The company was fined $300,000 for telling the press that it plans to put up prices.
With the government trying to exert that level of control over public perception, only a very trusting observer could believe that the official inflation data represents the unvarnished truth about price hikes.
The worry of course, is that China will continue to tighten. That increases the risk that the wheels will come off its economy. And the fact is that the economy is already slowing. Output growth slipped to 13.4%. That sounds massive by our standards, but it's the lowest since November. Retail sales grew by 17.1% again massive, but lower than the 17.6% expected. "The data looks bad", Dariusz Kowalczyk of Credit Agricole told Bloomberg. "The economy is slowing more sharply than expected but inflation is not."
Weaker demand from China could hit the rest of the world hard, and commodities hardest of all. And China's fear of inflation could have a further impact on US monetary policy, which I'll get to in a moment.
The high oil price is already changing consumer habits
Secondly, on oil prices, I have no real argument with the 'peak oil' thesis. But that doesn't mean oil should go up in a straight line forever. The high cost of fuel is already changing consumer behaviour. Petrol use in the US is down.
And high transport costs are also (somewhat perversely) helping US manufacturers. It's becoming more competitive for companies to set up shop in the US rather than outsource to China and incur the cost of getting the goods from there back to the US. If the trend towards 'localisation' continues, it has to have an impact on the amount of fuel used in global trade.
At our most recent Roundtable: Buy oil and invest in Japan 16 stocks to snap up now, one commodities investor noted that the main thing keeping oil as high as it is, is concern over the situation in the Middle East. Without that, he reckoned oil should be around $80-$85 a barrel.
How China's fear of inflation could mean a tighter US monetary policy
The third threat to commodities is a tightening of US monetary policy. The end of quantitative easing is approaching. Investors seem to have accepted that QE3 won't materialise but they still expect it to be launched if markets swoon post-QE2.
But what if it doesn't? Arguably the aim of money-printing has been to keep the dollar weak. The US and China have been engaged in a massive currency war. But now China is becoming more fearful of inflation than of an economic slowdown. It's gradually allowing the renminbi to rise. And that might just mean the US administration feels less need to keep destroying the dollar.
Meanwhile, there's political pressure, ahead of the 2012 elections, for the US to become fiscally 'responsible'. In normal circumstances, the year before an election is all about giveaways, and keeping the voters in bread and circuses.
But maybe not this time. The idea of money printing is not popular with voters. The whole driving force behind the 'Tea Party' movement is a general disgruntlement with bail-outs and the 'elites'. For your average US voter, things have got as bad as they'll ever get. They've lost their job and their house, or they know someone who has. The end of QE perhaps even a small rise in interest rates is not going to cripple them financially. They've been there already.
In fact, for many US consumers, the best thing that could happen to their personal finances is for the dollar to strengthen and commodity prices to fall. It might not be great news for stock markets. But for the 'real' economy, a fall in raw material costs would be the closest thing to a windfall they could get right now.
What does this mean for investors?
I'm not saying the US is about to hike interest rates. Particularly not with Ben Bernanke at the helm. And I'm not ruling out the launch of QE3 either. But I think it's worth highlighting that there are plenty of risks for commodities right now.
And it's possible just possible that the political logic in the US might swing in favour of a genuinely stronger dollar policy. The sell-off at the end of last week may have been investors experiencing a moment of clarity, rather than just a freak burst of panic. We'll be looking into this more in future Money Morning emails.
That's not to say that you should avoid commodities all together. The energy sector in particular and perhaps agriculture too remains promising. We'll have more on those in the next issue of MoneyWeek, out on Friday. If you're not already a subscriber, subscribe to MoneyWeek magazine.
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