In Scarcity & Real Wealth last month, I urged readers to be mindful of China’s ongoing fight to contain inflation.

If I were forced to pick a single barometer that could predict the weather for all types of real assets, it would be China’s inflation rate.

It’s no secret China has become the world’s growth engine. The bullish outlook for natural resources is predicated largely on the assumption of the country’s booming economic expansion.

Remove this lynchpin, and the story begins to unravel. And inflation is the one roadblock that could prompt Beijing to deliberately step on the brakes. Unfortunately, we’ve seen this exact scenario play out. Beijing is taking concerted steps to clamp the lid on inflation.

[ad#Google Adsense 336×280-IA]China’s central bank just fired another shot in this ongoing battle, tightening reserve requirements for the sixth time this year. Banks must now sit on 21% of their deposits, money that might otherwise have been loaned out to grease the wheels of commerce.

That’s fine; even race cars have to tap the brakes from time to time to stay on track. But unfortunately, the timing is poor: There was recently an unnerving report of decelerating factory output. Meanwhile, outstanding yuan loan-volume growth has slipped to its slowest pace in more than two years.

Investors didn’t need another reason to sell and were already jittery for several reasons, most notably a strengthening dollar and the end of the Federal Reserve’s quantitative easing program.

That’s why platinum prices have fallen in the past few weeks; oil has retreated back below $100 a barrel; coal, copper and natural gas have all registered losses. But silver has been the hardest hit of all.

With the amount of upfront cash needed to control a 5,000-ounce silver futures contract doubling from $8,700 to $16,000, the metal has backtracked from $50 into the low-$30s — the sharpest two-week decline since 1988.

When commodities make course corrections, they typically do so with conviction and speed.

I remain steadfastly positive on the long-term outlook for most natural resources. But it’s hard to look too far ahead when institutional traders are abandoning their positions en masse today. For those who may have forgotten the downturn of 2008, this is not a tide you want to swim against.

I’m not suggesting we’ll see a similar stampede this time around. But it doesn’t mean you have to sit idly by. Here are a few guidelines you might want to put into practice:

Have an exit strategy: There’s nothing more frustrating than watching a hard-earned gain on a stock unwind and disappear in a bout of panic selling. Setting or tightening trailing stop losses can keep you in the game while still shielding your profits.

Be proactive, not reactive: Don’t let market turbulence cloud your judgment. Being glued to the ticker tape will only tempt you to buy heavily on good days and dump everything on bad ones, neither of which is smart. Instead, marshal all the information at your disposal, keep your ears to the ground and stand by your convictions until the facts say it’s really time to pivot.

Look for disconnects: At times, it can seem that commodity investing is a one-way street on which everything is rising or falling in unison. But you don’t fuel your car with coal, or heat your home with platinum or manufacture a phone with cotton. Each of these markets is driven by its own unique set of variables — sometimes the good is discarded with the bad.

Lower your cost basis: Resist the urge to automatically double down on a stock just because it’s 20% or 30% below where you bought it. Cash flows (and fair value) are predicated on volatile commodity prices. So if demand slumps, then a stock that looked cheap at $70 might actually be expensive at $50. That being said, if there has been minimal change in the fundamentals, then an unfair pullback can be a great time to increase your stake.

[ad#article-bottom]And that’s what I’m doing with one of my favorite energy exploration companies.

There are reasons to believe this sell-off could prove to be a short-term correction rather than a protracted downturn.

The dollar’s newfound strength won’t last, particularly now that we’re seeing concrete signs of inflation. The deleveraging related to new margin requirements is a temporary phenomenon that may have run its course. And I’m not sold on the dour expectation that the global economy will stall out, crimping demand for metals and energy.

On the other hand, there are numerous needles probing China’s huge commercial real estate bubble. One stick, and the pendulum for copper, iron ore and other building blocks could whip violently from boom back to bust.

Action to Take –> I think a splash of cold water is just what we need to chill some of the more overheated sectors. Still, I’m holding on to plenty of cash on my Scarcity & Real Wealth real-money portfolio for the time being to take advantage of opportunities that arise.

 

— Nathan Slaughter

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Source:  StreetAuthority