Commodity outlook in the Year of the Dog
We are now in the Chinese Year of the Dog. With China being the main driver of commodity markets – and Britain’s blue chip miners enjoying a long bull run – what is the outlook for commodities for the rest of the year?
China’s seemingly insatiable desire for commodities will slow. The country is seeking to slowly transform from an export-led economy into one that is buoyed by internal consumer demand. Its leaders are seeking “quality” growth over “quantity”.
Because of the level of debt in the country, there will always be fears of a hard-landing for the Chinese economy. However, since a sharp slowdown at the start of 2017, China's economy has outperformed. GDP growth last year beat expectations, coming in at 6.9%, with 6.8% seen in the fourth quarter. This was its first annual acceleration in growth in seven years, defying concerns that intensifying curbs on pollution-causing industry and credit would hurt economic expansion. In the current year, the International Monetary Fund (IMF) sees growth of 6.6%.
Steel outlook vital
One of the most important commodities for London-listed miners such as Rio Tinto and BHP Billiton is iron ore, an essential steel-making ingredient. The price has been defying expectations of a pullback for months. Indeed, the Australian government said last month that it expected a 20% decline in iron ore prices this year, prompted by rising global supply and cooling demand from China. However, many market forecasts expect the price to remain largely flat. Changes in environmental law in China have also boosted demand for higher quality ore, such as that provided by the world’s largest mining groups as the ore produces fewer pollutants when it is put in a furnace. This has led to the spread between higher quality and lower quality ore widening.
Given its widespread use in construction, vehicles and power grid infrastructure, copper is considered a good barometer of the world economy. With expectations of accelerating synchronised global growth in 2018, demand for the metal should remain robust. China consumes around 45% of the world’s copper and a slowdown in its property market could cause the price to move off highs and also hit the price of steel, iron ore, coking coal, and zinc. This means strength in China’s “old economy” of infrastructure construction and house building are key to its prospects going forward.
Synchronised global growth
Demand outside China is also robust, with the world’s factories humming. Last month, global purchasing managers’ indices, which are measures of sentiment in the manufacturing sector, hit a three-and-a-half year high. This was boosted by higher activity in emerging markets, which are also tied into the commodity-demand story.
Obviously, a big risk for the Chinese economy is Donald Trump’s trade policy. Earlier this week, Beijing warned that US trade sanctions will hit the world economy. The US president has said he was "considering all options" including tariffs and quotas on China, after he accused the country of decimating the American steel and aluminium industries.
China’s foreign ministry spokesman Geng Shuang said that “any sign of unilateralism or protectionism will … worsen global trade issues and will hurt the recovering momentum of the world economy".
There is also the view that analysts have been, in general, overly cautious about the prices they use in their models after getting burned in 2015 when prices slumped. This implies that earnings estimates for the major miners could be in prospect as analysts’ model forecasts are upgraded to reflect the real world. This could, in part, explain why metals prices have already been more buoyant than many in the market had expected.
One other source of demand, particularly for copper, nickel and cobalt, is the rise of electric vehicles. In the latter part of last year, it appeared to be this issue that was boosting commodity markets, although excitement around this driver appears to have eased. Indeed, Elon Musk’s Tesla was supposed to have the world’s first mass-market electric vehicle, the Model 3, in full production by now, but issues with battery production have caused production delays.
Currency matters
There is also the dollar to consider, as all commodities are priced in the US currency. The greenback and commodities typically have an inverse relationship, as a stronger dollar makes dollar-denominated assets more expensive to buy in other currencies. The dollar has been surprisingly weak against other currencies, despite the fact that US interest rates are expected to rise more rapidly than elsewhere. This expected interest rate differential could cause a strengthening in the dollar, which would be negative for commodity prices.
So, for now the outlook for commodity demand looks relatively robust, although warning signs from the Chinese “old economy”, dollar movements and the oval office need to be carefully watched. The year of the dog may well have its day.
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