Why Are Commodities Sliding? Blame China

Art by Tim Bower

When China sneezes, the commodities markets catch cold. That twist on the old saying about the US and the world economy is apt as the Sino-American trade war worsens.

China’s extremely powerful President Xi Jinping has been slowing its economy in a bid to curb rampant indebtedness, among other objectives, which translated to ebbing commodity purchases. Earlier this year, things were looking up somewhat for commodities, as the US and China seemed about to forge a pact ending their trade dispute. Then last month, the trade clash got bad fast, harming China’s economy even more, with commodities as collateral damage.

“Trade tensions are a very big headwind” for commodities, said Paul Eitelman, senior investment strategist at Russell Investments.

The voracious intake of commodities that has defined China’s pell-mell growth since the 1990s is stunning. “China is the world’s largest consumer of commodities, bringing in half the world’s copper and half the world’s pork,” said Patrick Pascal, portfolio manager of the AC One China Fund. The curbing of that appetite has had a very quick effect on commodity pricing.

Statistics tell the tale of this decline. The Bloomberg Commodity Index, which measures everything from industrial metals to foodstuffs, has reversed its early 2019 run-up. From its April peak, it has plunged almost 6%.

The harm is most acute among the metals, which the Chinese have been buying in vast quantities as the nation became the earth’s second-largest economy. Lead is down 7.7% this year, and zinc is off 1%. Copper, a bellwether for economic conditions, saw the price surge it enjoyed earlier this year turn the other direction. Down 8.8% in May, it’s within two pennies of its depressed year-end 2018 level.

And the situation even is hurting oil. That marks a dramatic reversal. Oil had been steadily rising in price this year due to pumping cutbacks by the Organization of the Petroleum Exporting Countries and other producers. No more. US crude prices were down 16.3% in May.

The picture is more mixed for agricultural commodities, where forces beyond geopolitics are at work. In the US, a major foodstuff exporter, most prices are up lately—corn rose 14% in May, for instance—due to flooding across the farm belt, which is hindering planting and constricting future supply. US soybean exports suffered last year after Beijing slapped a 25% retaliatory tariff on them, but that barrier eased in December after the two sides called a truce. The resumption of hostilities is sure to damage US soybean shipments to China once more.

After the US, China is the world’s second-biggest importer, but it easily is the top destination for a whole range of raw materials. The trouble is that the Chinese economy is slowing. And this deceleration has been partly by design. China’s rulers want to shift from expanding its industrial base to creating a consumer market.

Also, they want to mop up some excesses created during their galloping industrial growth phase, when the Chinese economy was growing at a double-digit clip. Excesses like a worrisome amount of debts in companies and provincial governments.  And like stunning over-building in real estate—there are whole ghost cities, mostly uninhabited. Hence, the Beijing regime has decided to rein in its construction industry, which is voracious for capital.

The result has been reductions in the amount of commodities like steel that China buys. At the same time, it has stepped up its imports of food. To Chi Lo, senior economist for Asia at BNP Paribas Asset Management: “China’s per-capita grain consumption could easily double.”

China’s growth deceleration is on-again-off-again. Commodities worldwide took a dive in mid-decade as China ratcheted back its construction. Its slower demand for oil helped touch off a slide of many more commodities. Once China chose to rev up construction, the commodity market recovered.

An analysis from the Eurasia Group, a research firm, stated that over “the past decade, each period of Chinese economic weakness has been marked by a government-led stimulus program that has … sucked up commodities from the rest of the world.”

Now with China’s growth trajectory is off again, amid the escalating trade conflict between Washington and Beijing, the damage will be felt around the world. The International Monetary Fund recently projected that global growth will slow to 3.3% this year, down from 3.5%, its lowest level since the financial crisis. And that comes despite a still-strong economy in the US, which has a large effect on economic progress elsewhere.

Until recently, the trade war hasn’t seemed to have a measurable effect on the Chinese economy. In this year’s first quarter, the nation’s gross domestic product (GDP) grew 6.4% year-on-year, higher than estimates. Credit the stimulus program the China’s hierarchy put in place to cushion the tariff blow. “China’s economic health is at a critical juncture,” said Ed Egilinsky, head of alternative investments at Direxion, the fund sponsor.

Nonetheless, it remains to be seen how big an offset that stimulus provides. Beijing is taking a different approach than usual. Where before, China simply increased construction—which it did in a gigantic way after the 2008 global financial meltdown, to the tune of $2 trillion—now it has turned to using more modest developed-nation tools: a cut in the value-added tax and a looser loan policy for consumers and small businesses, as opposed to the mega financing once offered to huge state-owned and private corporations. “They’re trying to move up” to more sophisticated methods, said Cameron Brandt, director of research at Informa Financial Intelligence.

The effort, however, is less-ambitious than the brute-force spending on infrastructure in the past. The current stimulus amounts to about 1.5% of GDP, or $184 billion, by the calculation of David Dollar, a senior fellow at the Brookings Institution’s Thornton China Center. This maneuver is “much smaller than the big stimulus after the global financial crisis but apparently enough to already have had a positive effect on the economy,” he wrote in April. 

Not so fast. Let’s factor in the disruptions of May. After US-China trade talks ended without an agreement, President Donald Trump on May 5 hiked the tariffs on another $200 billion in Chinese exports to 25% from 10%. China fired back three days later, slapping new duties on $60 billion of American exports.

One sign that the trade tiff is affecting China is the fall in its factory activity in May, to 49.4 from 50.1 in April. Anything below 50 betokens a contraction. Likely upshot: less commodity imports needed by China.

Commodities by their nature are volatile. True, should the trade fisticuffs abate, then raw materials’ general direction is very likely to be up.  “If the trade issue is resolved in a reasonable amount of time, it will be bullish for commodities,” said Scott Colyer, CEO of Advisors Asset Management.

And even if the trade conflict drags on, a la the Cold War between the US and the Soviet Union, odds are that world commodity markets can adjust. Other emerging nations like India and Vietnam are poised to keep growing. “Commodities are fungible,” said Bob Browne, CIO of Northern Trust. “They’ll always find a buyer.”

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