Cross-posted from Kate Mackenzie at FTAlphaville.
Now that the possibility of a sharp slowdown in Chinese growth, or even an outright contraction, is getting some serious airplay, we can expect a ramp up in forecasts about what this will mean.
Here’s one from Barclays commodities analysts, Sudakshina Unnikrishnan and Jian Chang. They note that their China economics colleagues, having gifted us with the awkward ‘Likonomics‘ neologism, are also canvassing the possibility of a big drop in the country’s GDP growth rates.
Barclays’ base forecast is for 7.4 per cent GDP growth this year and next, but they think there’s an “increasingly likely” chance of a brief drop to rates as low as 3 per cent in the next three years.
Unnikrishnan and Chang write that in 2008 — ie, before China had quite stimulated its way out of a slowdown — aluminium and nickel consumption were hardest hit. But this was due to big inventories, both downstream and upstream, which have since thinned out. Therefore, they don’t expect such a dramatic reaction to another sharp slowdown:
Aluminium, nickel and zinc have already been in bear markets for some time, with balances in surplus, high stocks and prices already trading into cost curves (unlike before the 2008 financial crisis when prices were trading at a rather substantial premium to cost curves). The downside for these metals in a hard-landing scenario in our base metal analysts’ view is more limited than in 2008.
Goldman would beg to differ on the aluminium side — they argued last month the inventories have been suppressed by heavy buying from China’s strategic reserves; and they make the not unrelated point that overcapacity in the country’s own aluminium production industry appears to be wide, as cheaper producers come online.
Copper, however, is a different story:
The metal they feel is most vulnerable to a Chinese hard landing is copper as it has the furthest to fall with prices still trading at a premium to operating costs. It is also the metal most leveraged to China due to the country’s large import requirement. Further, they note that in terms of market sentiment, from a macro standpoint, the investment community would view a hard landing in China initially as a sell signal for copper. Copper price, hence, could face significant selling pressure. Modelling these scenarios our analysts note that copper prices could fall to $2553/t (over 60% from current prices), lead prices could fall to $850/t and zinc to just over a $1000/t (for both metals a 40-50% fall from current levels). In contrast, the potential downside for aluminium is a lot less, with a decline of 30% from current levels to a potential $1234/t.
As for oil, not so much to see there, thanks to Saudi Arabia. Barclays think in the 3 per cent growth scenario, China’s demand could fall by 4 to 5 per cent, but Opec would likely be quick to respond as it did in late 2008.
Gold, meanwhile, might experience a contrarian effect:
A hard landing could shake faith in the government and lead to a big fall in CNY-denominated assets which could mean gold becomes important for domestic investors to hedge what we think they will view as a greater set of risks than previously. It could be the trigger in moving China away from being a country that increases purchases at festivals or when inflation is high or when there’s a big fall in international prices, to one where gold is added more consistently to portfolios.
Well, it’s a theory, and one that kind of makes sense. Although there are certainly others.
Addendum: H&H here. I will add that China growing at 3% for a year would in all likelihood plunge iron ore to around $50, thermal coal to $60 and coking coal somewhat higher. I still see this scenario as a tail risk.
