China Trumps Ireland In Commodities Selloff

The ripple effects of Ireland have had a marginal impact on the commodities market.

Sure, commodities prices have been under pressure as concerns that Ireland's debt crisis will spread has weakened the Euro and strengthened the U.S. dollar index. But for energy and base metals in particular, the real story continues to be China.

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"It should come as no surprise that China, the largest global liquidity provider, trumps Ireland, a small, European country," says independent trader John Netto of M3 Capital.

Ireland might see a possible resolution to its debt issues—though there is no guarantee this debt contagion will not spread. But even if the EU/IMF deal is good news for Ireland, the country doesn't produce oil and is ranked 57th in world when comes to oil consumption. China, on the other hand, is the fifth largest oil producer in the world and the second biggest oil consumer after the U.S.

Moreover, as a prominent analyst noted today, money has been pouring into China thanks to foreign direct investment, ongoing trade surpluses, increasing bank loans, investors betting on further appreciation in the yuan, and the latest Fed-induced QEII injection. But what will happen to these money flows once China raises interest rates?

The consensus among many Wall Street analysts is the China will raise rates by the end of the year. The announcement at the end of last week by the People's Bank of China that is was raising its reserve ratio requirement was the second hint in two weeks of what China is likely to do. The market is still assessing what this could mean if the future driver of the demand for natural resources slows down.

MF Global's senior commodity analyst Ed Meir says, "Questions about Chinese monetary policy remains a persistent negative, as the authorities seem intent on doling out a steady diet of tightening measures. At one point, one of these moves—and we suspect it will be an interest rate hike that will fit the bill—will trigger a substantial correction in commodity markets."

Meir, like many analysts, anticipates the "flood of money into the Chinese economy" will likely prompt Chinese authorities to tighten by year-end.

The charts show the impact of anticipated tightening: The Shanghai Composite Indexhas fallen 7 percent in the past 10 days (since November 12), oil is down 6 percent and copper has slumped 4 percent in that period of time.

Countries that are heavily dependent on China imports, such as Australia and New Zealand, also face a regional risk from China. S&P downgraded the outlook for New Zealand's foreign currency debt today, citing a widening current account deficit and credit risks in the banking sector. The weakness in the Aussie dollar and New Zealand dollar is also weighing on commodities, traders say.