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Weekly Analysis

Commodities: All About China Policies
FNArena News - October 20 2011

By Rudi Filapek-Vandyck, Editor FNArena

On Friday UBS made a big switch in its investment view on commodities and commodities stocks and the investment banker made it clear it wasn't joking, issuing multiple documents and strategy advisories to its clientele across the world. The move would have caught many an expert's attention as, unlike peers at Goldman Sachs and Macquarie for example, UBS had been negative on commodities all year.

What makes UBS's switch even more remarkable is that "economic growth" inside or outside China does not feature prominently in any of the motivations to explain the change. So what does?

One of the key motivations for UBS analysts to turn more positive on prospects for commodities and commodities stocks is an unwinding of the short USD/long commodity carry trade that has caused so many headaches to many investors in August. It was always UBS's view that such a cathartic event was hanging in front of the sector, but now that we've gone through the inevitable clean-out in excessive market positioning, the analysts believe the market is en route to a new upswing. Mind you, the unwinding of these market positions is probably going to take a few more months to complete, but that's enough improvement for UBS to start preparing for a change in direction.

Other factors that have been taken into account are cheap valuations, overall market positioning, China's policies, the inventory cycle in the Western economies and dollar fund flows. Let's examine all these factors.

Shares in energy companies and miners have sold off quickly and relentlessly in the past months. The observation that many of these equities are now trading at significant discounts to net present value or on earnings and cash flow multiples not seen for many years is an observation that virtually enjoys universal support among all kinds of experts, across the world. Many also believe that as long as general risk appetite remains low on the back of slowing economies into 2012, this situation may not change anytime soon.

On the other hand, the gap between defensive stocks in the share market and commodities has now grown so wide that some experts believe a short term bounce for commodities stocks has become almost inevitable, if only for pure technical reasons. This may well be the bounce we are witnessing this week and last.

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