Commodity Pits: Chinese Related Plays Ready For Take-Off? Editor: BCA’s bullish argument for Chinese related commodity plays ties in with our view that 2013 will be characterised by stagflation as money velocity begins to pick up. It’s important to note that when BCA refer to deflation, they mean asset price deflation, not a contraction in the money supply.

Diminished global tail risks suggest that base metals prices, as well as other Chinese related plays, could outperform the broader commodity complex in the first half of 2013.

A variety of China plays have traced out similar patterns over the past two years. The most notable feature is that the trends in these assets have been dominated by non-China factors since early 2011. The EMU crisis in the second and third quarters of 2011 spurred a selling climax in our favorite China plays (industrial mining stocks, nickel, palladium and the Aussie dollar).

Resulting policy responses in the form of Fed QE2 and ECB LTROs did not bring deflation to an end, but were sufficient to “put in the lows” for growth-sensitive asset prices that do not have strong links to European macro trends, yet are responsive to EMU breakup tail risk. Since then, many China plays have formed an extended bottom even as the global growth backdrop has been fraught with uncertainty.

These dynamics should change in the first half of 2013

As long as the global economy does not slide back into recession and European tail risks can remain subdued, then the strength of the Chinese capex recovery will be the critical ingredient to determine the strength of the upswing in Chinese related commodity plays, as well as the base metals complex more generally.

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