Chinese Inflation Fueling Copper Bubble?

Copper, the metal that tells the fortune of the economy, may be on the fritz, with important implications for the global economic recovery.

iPath Copper ETN (JJC), a debt instrument that tracks the Dow Jones-UBS Commodity Index Total Return position in copper. JJC gained 13.95% in the two weeks ending July 24, an impressive run that bested many equity indices.

The two main theories for the rebound are Chinese growth and inflation, and the intertwining of these two ideas. Chinese banks loaned a staggering sum of money in recent months and it has fueled GDP growth as well as speculative buying of commodities, equities and real estate. China's central government also wants to diversify away from the U.S. dollar, and natural resources are a good way to "short" the dollar.

Furthermore, Chinese investors want to diversify away from the Chinese yuan. While the Federal Reserve's inflation met a stone wall of credit-sated consumers and businesses, in China credit flowed out of the banks and M2 advanced at a 28.5% rate in June. Moreover, in the U.S. inflation concerns often come from outside the mainstream, but in China even government economists have issued inflation warnings.

On the other hand, Simon Hunt, chairman of Simon Hunt Strategic Services, says that investors have shipped copper into China for storage purposes and this does not show up in the reporting system. If that's the case, investors may be misreading copper imports into China as industrial demand rather than speculative demand.

For some investors, it doesn't matter as long as someone is stockpiling commodities in anticipation of greater inflation, but as I've argued in the case of interest rates, inflation fears can stop inflation in its tracks.

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