Commodity Bulls Get a Gift

 | Dec 01, 2011 | 11:03 AM EST
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The coordinated moves by the U.S. Federal Reserve, the European Central Bank, the Bank of Japan and other central banks of the world on Wednesday to provide additional liquidity to the world financial markets was a surprising and significantly bullish development for the raw commodity markets.

In addition, on Wednesday, China announced it is dropping its reserve requirement ratio for banks by 0.5%. That in effect also eases China's monetary policy and is an overt signal that the country wants its economy to grow and will accept more commodity imports to achieve better economic growth.

The injection of liquidity into the world financial markets by the major world central banks and China's monetary stimulus announcement now suggest that major price lows are in place, or close at hand, for most of the major raw commodity markets.

The raw commodity sector had in recent months seen reduced investor demand due to worries about the European Union sovereign debt crisis spreading into a worldwide debt contagion that would in turn reduce overall demand for raw commodities.

Wednesday's coordinated move by the world's major central banks served notice that the world's major economic powers are in sync and are unified in preventing the E.U. debt crisis from worsening or from spreading to other parts of the world. This provided the overall market with fresh confidence the worst may now be behind us regarding market consequences from the E.U. debt debacle. U.S. and European stock markets rallied Wednesday, with most commodity markets also showing fresh price strength.

The notion among traders and investors that the E.U. debt crisis may finally be de-escalating did, by itself, breathe some new life into the so-called "risk assets," which include raw commodities. Complementing that fresh notion have been fresh U.S. economic data this week which suggest that the economic recovery is picking up steam. The better U.S. economic growth also suggests increased demand for raw commodities.

Importantly, Wednesday's actions by the major central banks and China augur increasing price inflation. Classic economic theory suggests that significantly stimulative monetary policy raises the risks of producer and consumer price inflation. Price inflation prompts investors to want to own those inflating "hard assets," such as raw commodities.

The other commodity-market-bullish development coming out of Wednesday's central bank and China announcements is the specter of a weakening value of the U.S. dollar against the other major currencies. The U.S. dollar index, which is a basket of six major currencies weighted against the greenback, immediately sold off on the central banks' proclamation of increased financial market liquidity. The easier access to U.S. dollars by the European Union financial sector is euro currency bullish and dollar bearish. Most major world commodities are priced in U.S. dollars, and when the value of the dollar declines against the other world currencies, those commodities become cheaper to purchase with the other currencies of the world.

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