The View from London: Is it still all about China?

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When discussing commodity markets and their outlook it is difficult, if not impossible, not to mention the C-word - China. Try discussing commodities at your next dinner or cocktail party and see if you are able to sidestep the issue of China. China accounts for a significant share of global consumption of industrial commodities, with the share over 50% in the case of aluminium, copper, nickel, iron ore and coal. What happens and is going to happen in China is therefore key to pricing trends. Commodity markets are nervous about China’s renewed focus on the current historically high metal prices and how the authorities may try to tackle that.

Should commodity markets be worried by tightening policy in China?

The C-word – China

When discussing commodity markets and their outlook it is difficult, if not impossible, not to mention the C-word – China. Try discussing commodities at your next dinner or cocktail party and see if you are able to sidestep the issue of China. China accounts for a significant share of global consumption of industrial commodities, with the share over 50% in the case of aluminium, copper, nickel, iron ore and coal. What happens and is going to happen in China is therefore key to pricing trends. Commodity markets are nervous about China’s renewed focus on the current historically high metal prices and how the authorities may try to tackle that.

Q2 seasonal demand considerations to the fore

The second quarter typically sees peak seasonal demand for metals as industrial activity gears up ahead of the slower summer months; construction activity in China reaching its peak, for example. Amid lagging supply metals prices should be trending higher over the coming months.

Base metals are rallying, with LMEX settling at its highest level in almost a decade, as the promise of more infrastructure spending, on top of other stimulus, make for a still bullish backdrop. Firm demand and tight supply continue to take centre stage as copper closed above $10,000/t. Copper and tin are now officially in record territory as they wait for other metals to catch up. Most of them have a long way to go, with aluminium being the closest.

But will bullish sentiment be hampered by signs that the Chinese government is looking to quell asset bubbles and tighten monetary policy. The PBoC has asked its major lenders to curtail loan growth for the rest of the year, following a surge in credit in Q121. China’s banks made a record CNY7.67tn of loans in Q121, up 8% YoY. This fueled further concerns of weaker demand in China.

Fears of higher inflation in China

After a strong rise in factory gate prices, authorities are also keen to quash any signs of inflation. Chinese factory gate prices rose at the fastest pace in three-and-a-half years in April as the country’s rapid economic recovery from the pandemic continued. China’s producer price index rose 6.8% YoY in April (forecast 6.5%), up from a 4.4% increase in March, according to the National Bureau of Statistics (NBS). This is the sharpest rise in China’s factory gate prices in more than three years and was mostly caused by the expectation of infrastructure projects in China and the US. Consumer prices rose 0.9% YoY in April (forecast 1%) as demand continued to improve, the NBS said. That was up from a 0.4% increase in March.

China will strengthen controls, premier Li said at a seminar recently, after panelists raised the issue of price pressures stemming from higher commodity prices. Indeed, it was comments by Chinese vice premier Han Zheng at the country’s Financial Stability Committee last week that higher commodity prices warranted close attention that prompted a recent spate of selling. As a consequence, China will strengthen controls on raw materials to help limit costs for companies after prices surged in Q1 and 2020.

China’s growth is moderating

Some economists note that the economy had reached “a turning point in the credit cycle” and loan quotas were being tightened. Historically, loan volumes are considerably higher at the beginning of the year as the PBoC makes regular liquidity injections before the LNY holidays. China’s growth is slowing due to an ageing population, high debt load, lower productivity and increasing international tensions will keep growth below the levels of the past 15 years. China’s economic growth in Q121 surged to 18.3% YoY, broadly in line with expectations, although a big part of this is due to the lower base in Q120 and slowed from Q420. On a quarter-on-quarter basis, the economy expanded 0.6%, according to the National Bureau of Statistics, well below expectations (well short of the expected 1.5%; last 3.2%). Although the overall first quarter growth was driven by production, more recent data suggests that services are taking over, while production growth is slowing. The expectation is that the recovery will lose steam as the initial pent-up demand dies out and because policy support is being scaled back.

The government is trying to curb leverage in the property sector and rein in record rates of steel production following a construction boom. Authorities are unlikely to hasten approval of infrastructure investment in Q221 even if economic activity slows. China is in its late industrialisation-urbanisation phase and, as highlighted in its 14th five-year plan, the long-term focus will shift from fixed assets investments into high tech, artificial intelligence, and green initiatives with a lower steel intensity per unit of GDP. China aims to peak its greenhouse gas emissions in 2030 and become carbon neutral by 2060. The steel sector, which contributes to 8-10% of carbon dioxide emissions is becoming a prime target for decarbonisation.

Chinese metals demand growth slowing but the level of consumption is still substantial

Chinese demand should remain supported as long as the credit expansion lasts. Even then, metals demand could still benefit if only policy modestly tightens, with the focus of the current 5-year plan on high quality development, supported by innovation and environmental targets. Traditional infrastructure spending will continue to grow, but at a slower pace. Innovation to manufacturing & ‘new infrastructure’ will benefit base metals.

Its not all about China as the rest of the world is growing again

On a positive note, any weakness in China could be mitigated by strong growth in the US as President Biden’s proposed $2.25tn infrastructure plan should see demand for industrial metals such as copper, aluminium, zinc, and nickel rise strongly. President Biden spelled out the details of a $1.8tn “American Families Plan” package, which will sit alongside a $2.3tn infrastructure package. This is in addition to the $1.9tn coronavirus relief package passed earlier this year and a $900bn stimulus bill passed under the Trump Administration. And so collectively, $7tn worth of either approved or proposed spending (over 10 years) is being front-loaded into the US economy, a third of total GDP ($21tn). For the first time in two decades the US economy seems likely to grow faster and contribute more
to global growth this year than China’s.

Metals demand over the next decade will benefit as the greening of the global economy boosts demand and supply struggles to keep up. Trafigura said that capacity utilization rates of its customers are the highest in a decade and that’s before stimulus money both in Europe and the US has started to flow. The US and Europe were becoming significant factors in the consumption of copper for the first time in decades. Before, it’s effectively been a China-only story. That is changing fast.

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