Global Markets Weekahead - Commodities, currencies and China in the limelight

By Clive McKeef NEW YORK (Reuters) - Commodities and currencies may continue to be in the spotlight for investors this week, as prospects for a Federal Reserve interest rate rise and the Chinese stock market slump work their way around global markets. With most commodities priced in U.S. dollars, the strength of the greenback, and the slowdown in China is leading a rout in commodity markets. U.S. WTI benchmark crude oil prices fell by 20 percent in July, the biggest monthly fall since October 2008, while Brent crude oil prices, the international benchmark, fell by 18 percent, the biggest monthly fall since December last year. Production from Organization of the Petroleum Exporting Countries (OPEC) is up more than 1.5 million barrels per day since the start of the year and the recently announced anti-nuclear deal with Iran will mean more oil on world markets. And despite the steep decline in the U.S. oil rig count, domestic oil production has risen about 500,000 barrels per day this year to 9.7 million barrels a day, the highest since 1971, according to the U.S. Energy Department. "If Saudi Arabia and Iraq keep running full tilt and Libya and Iran get their oil production back on track, crude prices could languish below $60 for the next three years," said Morgan Stanley analyst, Martijn Rats in a research note. "On current trajectory, this downturn could become worse than 1986,” he said. Copper prices fell 10 percent in July, the worst month since January and are now at their lowest levels since June 2009. Overall the Reuters commodity index fell 10.8 percent in July, its biggest monthly fall since September 2011. Reflecting the economic slowdown in China and sluggish growth in Europe and the Americas, international trade is also slowing. World trade has dropped over 2.0 percent in the last six months, the biggest decline since 2009, meaning world trade will likely have experienced its first back-to-back quarterly contraction since 2009, according to the latest Merchandise World Trade Monitor of import and exports published by the CPB Netherlands Bureau for Economic Policy Analysis. EMERGING MARKET CURRENCIES HIT Emerging market currencies are feeling the impact of the strength of the U.S. dollar, as expectations for the first Federal Reserve interest rate rise in a decade are already pushing up short term U.S. interest rates and making the greenback more attractive for investors. The Federal Reserve last week left the door open for a possible interest rate increase in September. The U.S. dollar has rallied 7.75 percent so far this year against the world's main trading currencies, after a 12.8 percent rise last year. Conversely, an index of emerging market currencies hit a 13 year low. The Brazilian real, the Australian and Canadian dollars, the Turkish lira, and the South African rand are among the most impacted currencies. And "the dollar’s recent rally may just be getting started," according to research from the BlackRock Investment Institute. "Since the 1970s when the Bretton Woods fixed-currency regime ended and currencies began floating, a typical dollar rally has lasted roughly six to seven years," according to Russ Koesterich, BlackRock global investment strategist, who noted dollar rallies tend to be self-reinforcing, leading to greater inflows into U.S. assets in expectation of further dollar appreciation. CHINA STOCK SLUMP MAY NOT BE OVER Slowing Chinese economic growth is taking its toll, not only on U.S. and European corporate earnings, but in the slump in Chinese stock prices. The Shanghai Composite stock index closed July down 14.4 percent, the worst month since August 2009, leaving the index off almost a third from its peak. Worryingly, the Chinese stock market is still seen overvalued, with the median price-to-earnings ratio for the Shanghai Composite Index hovering around 40, more than double the median P/E ratio of the U.S. S&P500 stock index, according to Guggenheim Partners' Global Chief Investment Officer Scott Minerd in New York. By another valuation measurement, the market-capitalization-to-gross-domestic product (GDP) ratio for China is currently above 60 percent, well above its average of 40 percent over the past 10 years. While Chinese stocks have been falling, growth at the country's big manufacturing companies has stalled, an official survey showed on Saturday. The official Purchasing Managers' Index (PMI) stood at 50.0 in July, compared to the previous month's 50.2. The 50-point mark separates growth from contraction on a monthly basis. The Caixin/Markit survey last month showed activity at smaller factories contracted by the most in 15 months. "It warrants more concrete policy measures to stabilise the real economy. Perhaps the funds used to prop up the share market could be used to support the real economy," ANZ bank economists Li-Gang Liu and Louis Lam said in a research note. More support from the People’s Bank of China (PBOC) to inject cash into markets may be a problem though if it allows the renminbi (RMB) to depreciate significantly. Chinese policymakers may want to avoid a currency devaluation ahead of the International Monetary Fund’s decision on the RMB’s special drawing rights (SDR) status in November. "In the meantime, my best estimate is that the PBOC will be forced to increase sales of Treasury securities to prop up the RMB as more capital flows out of China. I would expect up to $300–500 million of Treasury liquidation may be necessary to hold the line on RMB depreciation in the coming months," Guggenheim Partners' Minerd said. (Editing by Chris Reese)