China’s Muted Economy Can’t Nurture Another Commodities Super-Cycle
Many market participants believe the commodities super-cycle is all but over, yet others opine it is merely taking a break to return with the next cycle led by natural resources of a different sort, needed in the drive towards electrification of human mobility and a low-carbon economy.
Whichever side of the argument you happen to be on, there is likely to be agreement that China drove the commodities market either side of the global financial crisis.
Following the assetization of commodities that occurred towards the end of the last millennium, or to be precise in the final four decades of the last millennium; this millennium any commodity value experiencing double-digit inflation-adjusted price growth on an annualized basis can be deemed to be in a super-cycle.
Courtesy of China’s own double-digit growth until a recent cooling of its economy, a plethora of commodities both soft and hard experienced such growth between January 1, 1998 and June 30, 2008. It led people to opine that a commodities super-cycle was occurring. Forget double-digits, the price of oil rose 1,062% and that of copper rose 487% over the said period, according to Bloomberg data.
Then a U.S. sub-prime mortgage crisis became a full blown global financial crisis halting that super-cycle. But in a bid to minimize the effects of the global slowdown on its economy, China announced a 4 trillion yuan ($586 billion) economic stimulus package on November 9, 2008, centered on infrastructure and social development.
Commodity price growth initially limped, and in subsequent years jumped upwards. But fast-forward to 2019; and it’s a changed macroeconomic landscape. China’s economy is making a transition from being manufacturing-led to a services-driven model, unable to match double-digit growth the commodities market has grown accustomed to in recent decades.
Since commodity prices are informed by marginal costs subject to intermittent deflationary or inflationary disruptive forces, this expected maturing of the Chinese economy is troubling.
In 2017-18, when China’s perceived economic adjustment was clear for all to see, commodities ended up as the worst performing asset class. Crude oil, the sphere’s poster natural resource, ended 2018 down 18% (though not entirely down to Chinese demand) while natural gas ended 3% lower on an annualized basis.
However, neither was the worst performing commodity. That dishonor fell to Lithium (-30%), despite it being central to a rising need for rechargeable high-performance batteries from mobile phones to electric vehicles; a manufacturing segment where China leads in volume terms.
That’s because alongside being a top consumer of lithium, China also happens to be a top producer of the silver-white alkali metal. It is only behind Australia and Chile in terms of output, and the world leader in terms of proven reserves. That neutered the scope for it factoring in China’s still decent appetite for metals, unlike copper which has seen an upturn fortunes since 2016 lows (+70%).
But China’s overall commodity consumption is nothing like it was in the last decade. Beijing is also currently embroiled in a trade spat with U.S. President Donald Trump, involving tariff salvos that have implications well beyond bilateral trade between U.S.-China.
A recent poll of economists surveyed by Bloomberg suggests China’s 2019 GDP growth will be lowered by 0.3 percentage point by the rise in U.S. tariffs on $200 billion of imports from China, following the latest escalation by Trump. If more tariffs are slapped by the U.S. President – to cover all Chinese goods – then a 0.6 percentage point drop in the 12 months thereafter appears to be the median figure given by those polled.
However, even before the latest escalation of the ongoing trade spat began, data had been pointing to lower economic activity. According to China’s National Bureau of Statistics, the country’s April industrial output came in at 5.4% on an annualized basis down from 8.5% in March, April retail sales growth came in at 7.2% (versus 8.7% in March), and fixed-asset investment at 6.1% (versus 6.3% in March).
Kit Juckes, Head of FX at Société Générale said China’s activity data has surprised on the downside. “Looking through the monthly volatility, China is still on track of stabilization but the recovery is probably not going to be as strong as some are hoping for.”
While an economic stimulus from Beijing is imminent, its nature would be very different from 2008. Back then, an infrastructure-focused stimulus supported not just copper and iron ore prices, but also those of zinc, lead, nickel and fossil fuels.
The stimulus measures expected in 2019 will still offer significant support to the Chinese economy but will feel different, according Marie Diron, Head of Asia Pacific, Middle East, & Africa Sovereigns at Moody’s.
Speaking at the rating agency’s Emerging Markets Summit in London on Thursday (May 16), Diron said: “Market expectations are that Beijing’s move will be more skewed towards tax cuts. Whether it would be as effective as previous initiatives remains to be seen. Moody’s predicts China’s GDP growth in 2019 of just above 6%, accompanied by a significant tightening in credit.”
And the ongoing trade spat, while negative for the U.S., carries bigger problems for China given trade imbalances as it exports more goods to the U.S. rather than the other way around. That’s why Beijing’s reaction to each escalation by Trump via retaliatory tariffs of its own is lower in dollar terms.
“Chinese companies will be negatively impacted whether you take direct U.S. action into account, or domino effects on the supply chain. All at a time when corporate leverage remains a risk,” said Gary Lau, Head of North Asia (ex-Japan) Corporates at Moody’s.
And with Trump in the White House, the issue is not going away anytime soon, Juckes of SocGen added. “China will remain a bone of contention whether the current trade dispute is resolved or not, and the President might turn his attention to what many in Washington view as ‘overvalued’ dollar.”
That might open another can of worms for the commodities trade. Given such variables, selective commodities might fare better than others. For instance, the commodity that outshone others in 2018 was uranium (+20.3%); but the uptick, albeit from a low base, had little to do with China.
The price rise came because the supply and demand equation for uranium has resulted in a tightening of the market. Following Japan’s Fukushima nuclear tragedy in 2011, countries began to shy away from nuclear power generation in tandem with a short-term surplus of Japanese uranium stockpiles.
The perceived nuclear switch-off meant the number of mining companies declaring interest in uranium fell by 90%. Then dwindling Japanese stockpiles, uptick in favor for nuclear power generation and lack of resource mining plays sent the uranium price soaring last year. Quite like uranium there will be other winning commodity plays, but a holistic China-driven commodities super-cycle is unlikely to materialize.