What does China’s factory sector growing at its strongest pace in six months have in common with the US Federal Reserve’s decision to keep buying bonds? Both failed to boost commodity prices much.
The flash HSBC Purchasing Managers’ Index (PMI) rose to 51.2 in September from August’s 50.1, the highest level since March and strengthening the view that economic growth in the world’s largest commodity consumer is regaining momentum. The improvement came days after the Fed surprised market watchers by keeping its bond purchases at $85 billion (Dh312 billion) a month, judging that it is still too early to taper monetary stimulus, given the nascent economic recovery in the US.
Both developments should be positives for commodity prices, as both point to the likelihood of stronger growth in the next few months in the world’s two largest economies. While the Fed decision did give a small boost to some commodity prices, it didn’t last, with London benchmark copper having given up more than half of the 2.1 per cent rally on September 19, the day after the Fed announcement.
Brent crude oil failed to maintain its Fed-inspired gains. Asian spot iron ore is marginally higher than before the Fed decision to delay tapering, having risen 10 cents to $131.80 a tonne the day after the announcement, and adding another 60 cents to $132.40 after Monday’s flash China PMI.
It is perhaps easier to find reasons why the Fed decision didn’t move commodity prices much, given that while the move was unexpected, the market has taken the view that tapering is still likely before the end of the year. The scaling back of bond purchases by the Fed may be a double-whammy for commodity prices, since it is likely to boost the US dollar as well as take some wind out of the US economy’s sails.
But the China PMI should be good news for commodity demand and prices, as rising factory production boosts demand for industrial metals and for oil products. There may be several factors limiting the impact on commodity markets from China’s improving economic numbers.
The first is the relatively weak link between PMI outcomes and actual import volumes. Looking at iron ore, for most of 2010 imports trended down, and they only started accelerating toward the end of the year and the start of 2011, just as the PMI was starting to weaken.
More recently, the official PMI has been meandering in a narrow range near the 50-level, but iron ore imports have been surging, reaching a record high in July of 73.1 million tonnes. However, if you compare iron ore imports to the spot price, it becomes clearer that Chinese buying accelerated after last year’s sharp price decline.
It also shows the weakest month for iron ore imports this year, namely February, came after the price had rallied almost 80 per cent between September last year and January this year. It’s much the same for copper and crude oil, where the link between the PMI and import volumes is tenuous at best.
There is a far better link with prices and inventory levels. Recent strong months of imports are believed to have led to re-building of inventory levels in key commodities in China, and this, coupled with prevailing high prices, will serve to limit commodity import growth for the rest of the year.
In crude oil, China’s commercial inventories were 9.7 per cent higher at the end of August from a month earlier, according to a report by the Xinhua news agency. Refined product stocks were 5.3 per cent lower, but this doesn’t necessarily mean crude imports will gain. It is more likely that refinery throughput will rise as plants use some of their crude inventories to boost product stocks.
China’s steel rebar inventories rose to 6.08 million tonnes last week from 5.97 million the week before, according to consultancy Mysteel, suggesting that production is still too high for domestic requirements. Another headwind for higher commodity prices is the view that supply gains will overwhelm demand growth, especially in iron ore and copper.
New iron ore capacity in Western Australia state and expectation of higher copper output this year mean buyers may be prepared to hold off in hopes of weaker prices. Finally, there is concern the rebound in China’s PMI is not sustainable as it is built on the old economic drivers of credit-fuelled building and infrastructure spending, rather than the government’s planned switch to consumption expenditure.
There are doubts as to how long and how much China’s authorities will be prepared to spend on railways, leading to fears that 2014 will once again see economic growth stalling.
The scepticism over China’s recovery is perhaps unusual for commodity markets, which have tended to rally hard on good news. Perhaps this time investors need more evidence of sustained demand growth before believing in higher prices.