It’s over. The commodities super cycle has ended, in a nuclear bang not a whimper, from Bloomie:
China’s stock rout spread to the country’s commodities markets as investors rushed to raise cash.
Everything from silver to sugar to eggs tumbled with the Shanghai Composite Index, which crashed to a three-month low on Wednesday. Government measures to stabilize equities are failing to stop a stock market collapse.
“People are selling everything in sight to get their hands on cash,” Liu Xu, a trader at private asset-management company Guoyun Investment Co. in Beijing, said by phone. “Some need to cover their margin calls in the stock market, while others are gripped by fear that the Chinese economy will be affected by this crisis.”
Metals including nickel and silver on the Shanghai Futures Exchange fell to their daily limits, while rubber entered a bear market. The volume of copper traded was almost six times the three-month average. Steel rebar and iron ore, as well as eggs, sugar and soybean meal dropped to the lowest level allowed by their exchanges.
There are three reasons why. First, supply has overhauled demand with massive expansions coming on-stream just as China goes ex-growth. Second, the monetary impulse of a weak US dollar has reversed. Third, markets are massively destocking out of commodities. That’s your big pile of dry wood. The match is the Shanghai crash and a huge Chinese margin call.
The entire cycle is blown to bits. Here’s Goldies via FTAlphaville:
The negative feedback loop is significant. The deflationary impulse created by lower commodity prices reinforces a stronger US dollar, as witnessed by recent moves in FX markets that resulted in weaker commodity currencies. This decreases the cost of producing commodities in these countries through lower wage costs that are priced in the weaker local currencies. Further, this deflationary impulse reinforces a stronger US economy and higher rates. The higher rates in turn raise the cost of funding for emerging markets, which reinforces the need for emerging markets such as China to deleverage and deal with significant macro imbalances developed over the past decade. This ultimately reduces the demand for commodities, particularly those that are tied to investment such as copper and iron ore.
In 2015, the shift in the composition of Chinese economic growth away from investment in productive capacity that is commodity intensive and towards more consumer-driven economic growth has been significant. Recent Chinese macroeconomic data suggest that investment’s contribution to GDP growth declined from 50% of growth to 15% in the first quarter. This helped to push “CapEx” commodities like copper to new lows for 2015. Although spot oil prices still remain above the lows of 2015, long-dated oil prices (a measure of the normalized oil price), base metal prices, bulk prices and precious metal prices have all made new 2015 lows in the past week.
…While we have been expecting lower prices for CapEx commodities (copper, iron ore) for some time now, the speed of the recent declines has been unexpected, taking prices rapidly towards our bearish 12 month forecasts. Furthermore, the metals where we had been expecting higher prices later in 2015 on diverging supply fundamentals (nickel and zinc) have also seen similar rapid prices declines over the last few days.
Weakness in the Chinese domestic equity markets has recently become a talking point. However, we continue to believe that the equity sell off was mostly a catalyst in commodity markets and that the more far reaching implications are more erosion in the confidence in Chinese policy makers.
For commodity markets, what really matters is underlying demand weakness that started before the policy generated equity rally, particularly in the commodity-intensive fixed investment and heavy industry sectors. As such, while recent metals price action poses significant downside risks to our metals forecasts, it is still consistent with our bearish macro views, as our “Deflation, Divergence and Deleveraging” macro themes continue to play out. Our suite of indicators continues to paint a downbeat picture for Chinese commodity demand. Our China Current Activity Indicator (a broad-based alternative measure to GDP) is tracking growth around 6%, FAI has fallen to 11.4%yoy (down from over 17% a year ago), apparent steel demand continues to decline, and our GS China copper demand indicator is also in negative territory.
I still don’t see huge impacts from the Shanghai crash on Chinese growth in the short term. From Nomura:
There are several channels through which the current equity correction could lead to some latent financial turmoil. First, brokerages, trust companies and private lenders have extended an estimated RMB3-4trn in margin financing to equity investors, based on some data form the exchange and our estimates.
Of this, we believe about RMB1.9trn has been extended through brokerages and we estimate about RMB500bn through trust companies.Margin financing via brokerages has already fallen to RMB1.9trn from its peak of RMB 2.4trn since the correction began. The leverage of margin financing done through brokerages and trust companies is generally under 3x, and the lender’s position is generally well protected as long as the equity market remains liquid enough.
Currently, daily trading is still above RMB1trn, suggesting that liquidity is not an issue, although the imposed ±10% daily price band does pose some restriction on the liquidity of some small cap stocks. Overall we believe the risk to financial institutions involved in margin financing is limited.
Second, bank loans to large shareholders of listed companies who use their shares as collateral may face a rising risk of default if the index continues to fall. However, as mentioned above, the value of such loans only accounts a tiny share of banks’ balance sheets, thus the financial risk through this channel is also limited.
Those are pretty limited immediate impacts on Chinese growth. But the real impact is bigger and more subtle. Chinese authorities have engineered successive booms to keep their growth rate at unnatural highs for two decades. The first boom through the millennium was in manufacturing. The second boom after the GFC was in credit and construction. They’ve just tried their hand at a third boom in equities and failed. By doing so they have unleashed risk upon the broader Chinese economy, or put another way, accelerated their structural adjustment towards market mechanisms allocating capital, and everything will now be slower than before.
The impact for Australia is plain enough. We are going to see:
- carnage in national income and recession;
- the swift exhaustion of monetary and fiscal ammunition;
- an historic housing bust and bank bailout, and
- a much lower currency as well as long and painful rebuild of non-resource tradable sectors.
In other words, an economic adjustment on speed. Go to cash.
