Global commodity snapshot: prices rally, despite China crackdown
Dan Smith of Swann reports on how commodity price records continue to be broken as OECD demand for a variety of metals and materials accelerates.
Commodity prices continued to climb in May, with rallies seen in the base metals, gold and crude oil. Iron ore was also higher, but it had a bumpy rise, with prices up sharply early in the month, before pulling back. Overall, global commodities demand is being boosted by the lifting of lockdowns in the OECD area, as well as persistently strong demand from China.
However, while physical demand is certainly growing strongly in many markets and areas, there are clear signs of bubbles developing and speculative activity is also playing a role in taking prices higher in both China and the rest of the world. Copper, iron ore, palladium, US steel and US timber prices all reached record highs in recent weeks. Across a broad spectrum of 25 major industrial commodities, the average increase in prices was 95 per cent year-on-year by the end of May.
OECD investors are looking to buy hard assets as a protection against inflation. Citigroup notes that commodity assets held by fund managers reached US$648 billion in April – a fresh record high. Given that US core personal consumption expenditure (the Federal Reserve's preferred measure of inflation) reached 3.1 per cent in April – the highest since 1992 – investor concerns are understandable.
Moreover, China is getting worried about froth in its markets and the impact of high prices on its manufacturing sector. Factory gate prices in April jumped by 6.8 per cent – their fastest increase in three years. In May, the country’s economic planning body said it would crack down on hoarding and monopolies in commodities, and this helped to bring down domestic prices in the second half of the month.
The drop in Chinese steel prices was particularly striking, with HRC and rebar prices down by over 20 per cent in the second half of the month, showing the power of government intervention (Figure 2). The Chinese government has wide-ranging powers to intervene in financial markets, as well as alter the underlying drivers of supply and demand should it see this as necessary.
Credit conditions are also being tightened in China, which supports the idea that slower economic growth is coming. According to Oxford Economics, Chinese GDP growth will slow from 8.9 per cent in 2021 to 5.5 per cent in 2022. The first quarter of this year saw a surge in bank loans as the government was keen to stimulate activity, but new bank loans fell by more than expected in April and money supply growth fell to a 21-month low. This reinforced slowdown fears.
While China would also like to reduce its dependence on imported iron ore, it continues to rely heavily on the seaborne market, with Australia accounting for the lion’s share. Ironically, higher quality iron ore from Australia and Brazil helps China reduce its carbon emissions, creating a conflict between environmental concerns and a desire to reduce reliance on the international mining companies.
The Australian mining sector has proved to be relatively resilient during the COVID-19 crisis, where the spread of the virus has largely been constrained by strict border controls and lockdowns. Iron ore production for the country was barely changed last year and BHP achieved record production levels at its Western Australian operation. While copper output for the country fell by four per cent in 2020, this was largely for structural reasons, as Mount Isa and Prominent Hill scaled back their operating rates.
Looking ahead, global demand for commodities looks set to remain strong, but we expect prices to face stiff headwinds and the supply response will largely determine where prices go next. Iron ore looks particularly vulnerable to a further setback, as many of the challenges for producers are temporary and China is both trying to slow down steel demand and boost the proportion of scrap used in the steel mix at the expense of iron ore.
The upside for oil is also becoming increasingly limited. While prices are low in relative terms compared to copper and iron ore, this appears to accurately reflect the ample amount of spare capacity being held back by OPEC. So far, OPEC appears to have reached a happy medium of prices that are good enough to restore decent levels of profitability, but not high enough to encourage the US tight oil sector to change its mindset and accelerate drilling and production. Another leg higher in prices is likely to upset this delicate balancing act.