Home sales are continuing apace in Chongqing, one of the few cities not imposing measures to cool the overheated market © Bloomberg
Base metal and bulk commodities are in the midst of a mini-renaissance. While supply always gets focus, it is the demand side of the equation that has been more influential in pushing prices higher this year. And, as with most things in commodities, the incremental shift has come from China.
There is always a tendency to focus on supply in commodity markets, as this is the area of greatest visibility. However, this has done more or less as we expected at the start of the year; falling across many markets because of a lack of growth projects.
But as commodity prices have recovered, the pressure to cut supplies further has evaporated and that is a problem. For fundamentals to truly improve, permanent capacity cuts are required across many markets — particularly in steel and aluminium.
Looking at previous cycles, it is demand that tends to lead a recover, while supply reacts. Production cuts often just mean idling capacity and/or the transfer of assets from one operator to another. Actual permanent closure of productive capacity tends to be rarer, hence the quick supply response to any signs of an improved market.
On the demand front, there has certainly been an improvement this year and we have increased our expectations for all major industrial metals for the next 12-months.
China’s renewed fixed asset investment push has been core to this. Every renminbi spent in infrastructure and construction in China is more metals-intensive than one spent elsewhere in the economy.
We now view Chinese government policy as attempting to balance between the twin aims of reform and growth. While 2015 was about reform and anti-corruption, 2016 has been more about ensuring wider growth does not fall below the magical 6.5 per cent threshold via the old lever of fixed asset investment in infrastructure.
That said, the swing factor has arguably been the construction market, where a year-on-year gain in new projects on the back of resurgent sales has exceeded expectations.
So, the single most important question for metals and bulk commodity markets is how long the Chinese government can keep the fixed asset investment pump running hard. This becomes increasingly pertinent given the twin targets around reform and growth are close to being mutually exclusive. We expect no change in strategy before the politburo seats are finalised in mid-2017, with fixed asset investment remaining strong through this period.
This likely means a renewed liquidity push in early 2017, which will be supportive of metals demand for the coming 12 months. Beyond this point, however, growth projections look increasingly challenging, particularly as targets for the 13th five-year plan are clearly being front-loaded in their delivery. It will not collapse though: the central government says it will have a “three-year rolling investment plan” for infrastructure projects to ensure stable growth while continuing their reform push.
To be clear, fundamentals do not point to any sustained inflationary bottlenecks other than in metals such as zinc where there are raw material constraints. The long-term challenges of overcapacity and lower industrial demand growth than recent norms are still very much in place.
And much rides on Chinese policy, and even our revised demand growth would be considered sub-trend. But confidence that January’s China growth scare marked a price bottom continues to grow.
The result is a window of opportunity for metals and bulk commodity producers. 2016 has brought a sense of relief inasmuch as the Armageddon scenario many feared is not playing out. However, we have not seen enough strong decisions made on restructuring to be entirely confident in the outlook.
Given we expect a scenario through early to mid-2017 where fears of a China economic collapse are muted and the country is pulling on imports rather than having to be the clearing house for commodity markets, this will further ease balance sheet pressures. How miners and big producers react to this backdrop will determine the next cycle.
The Commodities Note is an online commentary on the industry from the Financial Times
Colin Hamilton is the head of commodities research at Macquarie
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