China’s soft landing calls for cautious commodity outlook
Monday, 02 April 2012 | 11:00
Is a weaker outlook for commodity prices good or bad for India? The answer really depends on which side of the industry you are on. A company producing commodities and its shareholders will face tough times. If agricultural commodities slip, too, then farming incomes will be hit.
But firms making consumer goods-be it home, personal care and food products, or consumer durables-will get cheaper inputs. They can choose to grow demand by offering discounts or retain cost savings to earn higher margins. Falling commodity prices would mean lower inflation, therefore, lower interest rates, which may spur consumer demand and capital investment and, therefore, be good for economic growth.
This construct becomes important because China’s economy is being steered by its government to a soft landing. Iron ore producers say China’s appetite for ore is not as strong as expected and could affect their performance.
The recently released HSBC Flash China Manufacturing Purchasing Managers’ Index was at a four-month low due to weakening domestic demand conditions. The implications are that China’s appetite for importing commodities might wane.
Apart from hurting sentiment, excess supply could also influence prices. Latest data for a broad commodity index, the Thomson Reuters/Jefferies CRB Index, shows a 2.8% decline in a month.
Prices of three non-ferrous metals—copper, aluminium and zinc—are either flat or have declined. These fears have dragged down currencies of nations such as Australia and Brazil by about 2.2% and 6%, respectively, in a month on fears that China’s slowdown could hit exports.
This is a developing story, and a complicated one. Crude oil prices still hold firm despite these concerns, and have moved up 2% from a month ago. That keeps energy costs high for all producers. Some agri-commodity prices are holding up well, too. Soya bean and crude palm oil are sharply up from a month ago due to supply-related reasons.
Economic growth in the US is another complication. Recent indicators show that the euro zone continues to be under pressure, but the US economy is showing signs of recovering. Though premature at the moment, if it sustains and turns healthy, it could offset slower growth in China.
Liquidity is another factor that influences commodity prices, as most commodities are traded in the financial markets. News that the US Fed continues to support an easy monetary policy regime cheered markets on Tuesday. Ample liquidity can soothe the effect of worries on the demand-supply front, or exacerbate them when the liquidity situation changes. Even in China, if monetary policy is relaxed due to slowing growth, it can spur consumption growth, which could again revive domestic output growth.
What does all this mean for Indian companies? If China’s growth slowdown sustains, then commodity prices will fall, which will hurt Indian commodity firms, especially in the metals space. But consumption-oriented firms will benefit. A fall in crude prices is more important for India. And, input costs are just one aspect. Demand is equally important for firms to do well, for which India’s economic growth has to accelerate.
That is a complicated situation, one which should make investors in commodity stocks cautious.
Source: Live Mint