Chemical M&A activity in an unstable economic environment such as that which predominates today may be difficult to predict. Taking stock of the factors contributing to economic instability, as well as the current condition of the chemical sector and how commodity sectors in general respond to the global pressures on financial markets and economic recovery should offer some indication of what to expect from the industry and M&A’s in the next few quarters.

At this point three main forces are mucking up the global economy – and because of the way the mortgage and housing bubbles promoted global financial interdependency, the global economic woes are reflected in most major economies domestically. First, China. China’s huge appetite for commodities, its currency controls and the resultant overvaluation of many other currencies (the U.S. dollar, the Peruvian sol, the Brazilian real, the Japanese yen, etc.), and its housing bubble are all adding confusion to several markets by distorting financial instruments and muddying data that experts use to anticipate market trends. As China eases restrictions on its currency, expends some of its foreign capital reserves, and increases interest rates to slow its economy, look for capital flows to stabilize and the commodity price boom to normalize.

Second, developed economies, most notably the United States and large parts of Western Europe, have shown sluggish recovery in 2010 despite legislative efforts – and sometimes ill advised monetary policies – designed to stimulate domestic demand. The result is two-fold: without developed economy consumers spending, many commodity exporters have seen traditional markets dry up; and with the majority of chemical sector M&A transactions still including at least one interested party from North America, a weak U.S. economy dampens chemical industry transactions and adds an extra layer of cyclical effects that must be interpreted to anticipate how policy changes will affect transaction activity.

Third, owing partly to China’s primary commodities consumption, which remained strong through the downturn, many developing economies were able to amass huge reserves of foreign capital. This gave them the ability to finance domestic demand stimulation while maintaining sound fiscal balances, which, coupled with primary exporters’ ability to ride out the downturn and remain profitable, has led economic growth in these economies to far surpass expectations, roiling analysts’ predicted rankings. As such, interest rates in these economies remain high, drawing capital inflows in surprising volumes and giving investors from these markets more disposable capital to fund chemical sector M&As.

The fallout of all this is complex, but one of the main indicators to focus on is government spending. Buoyed by many of the previously mentioned issues, which have made credit more available, commodity prices suggest that chemical companies profits will remain strong through the end of 2010 and into 2011. Furthermore, chemical companies have also been able to clean up balance sheets and gain access to more capital, so the devaluation of developed economy currencies and rising petrochemical prices should prompt a number of buyouts as these companies attempt to secure technologies and market-access that will allow them to protect their long term profitability and keep costs down.

So despite immediate unpredictability in commodities activity, mergers and acquisitions in the unstable economic environment should become more predictable and remain favorable for shareholders in the next few quarters.

John Brown is a retired financial advisor specializing in M&A deals. If you would like to learn more about merger & acquisitions in specialized niches visit Valence Group.