Because this time “it’s different”. Last night witnessed some aggressive rebounds in commodity prices thanks, in part, to a new Goldman note assuaging rising concerns for commodity prices emanating from the imminent Chinese slowdown. There are some days when Wall Street really does take the cake.
Buy the China led dip. The bullish commodity thesis is neither about Chinese speculators nor Chinese demand growth. It is about scarcity and the DM-led recovery. Prices retraced 3% after Chinese warnings over onshore commodity speculation, yet the fundamental path in key commodities such as oil, copper and soy beans remains orientated towards incremental tightness in H2, with scant evidence of a supply response sufficient to derail this bull market.
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China has lost pricing power. The velocity of the DM demand recovery means that China is no longer the marginal buyer dictating pricing, as it is crowded out by the Western consumer. The market is beginning to reflect this, as copper prices are increasingly driven by Western manufacturing data rather than Chinese. This is a reversal from the 2000’s, with China now the incumbent consumer as the US was when emerging Chinese demand squeezed out marginal US consumers.
History of attributing paradigm shifts in prices to speculation. China’s current crackdown on commodity speculation mirrors similar moves by the US in the mid-2000’s. When commentators are unable to understand what is driving such a paradigm shift in prices, they attribute it to speculators – a common pattern throughout history which has never solved fundamental tightness.
Speculators reflect fundamentals and reduce volatility. Data shows net-specs track fundamentals as the specs simply translate fundamental information into price discovery. History shows that banning them typically leads to more price volatility. And discouraging precautionary inventory building by consumers will leave China even more exposed to crowding out by US firms who are able to pass commodity inflation through to consumers, raising prices dollar for dollar with raw material costs.
Weak Chinese demand validates the bullish thesis. The immediate reason for the greater US pricing power is the large US fiscal stimulus that is absent in China; however, we believe there are also structural factors that makes this a paradigm shift. China no longer benefits as much from its comparative advantage in low-cost labour, global trade and its previous apparent indifference to the environmental impact of GhG emissions. This ultimately creates a weaker margin setting onshore.With scarcity starting to generate shortages and higher prices, the Chinese are the first consumers to be priced out.
Take a global view. Our view for a commodity super-cycle is a global, not China-centric, view. It is predicated on globally synchronized policy aimed at REV’ing global commodity demand—Redistributional policies (the ‘War on Income Inequality’), Environmental policies (the ‘War on Climate Change’) and Versatility in supply chain initiatives (the trade war). This structural rise in global demand growth against structural supply constraints due to the ‘Revenge of the Old Economy’ makes this commodity super-cycle a worldwide phenomena unlike the 1970s super-cycle (US and Europe) or the 2000s super-cycle (BRICs), leaving it robust to pockets of softness.
OK, so let’s unpack this.
First, the argument is a false binary on two fronts:
- The developing circumstances for commodities are not a question of speculators versus fundamentals. That is to run with CCP rhetoric. Positioning for iron ore is not extreme. It’s more aggressive in base metals but not extreme, either.
- The notion that the Chinese consumer versus US consumer of commodities delivers pricing power to the latter is silly if the former is going to slow more. How does that equal “scarcity”?
Which also exposes Goldman’s false assumption. That Chinese stimulus is “missing” in today’s pricing equation. China supercharged its usual apartments and infrastructure building over the past year which is now running alongside catch-up growth to deliver a huge short-term demand boost to metals. What is the following, chopped liver?
This also raises the question of why is Goldman comparing commodity prices to PMIs to prove its case when the relationship between the two is tenuous.
The right framing of the commodity question in the short and medium-term (say, to the end of 2022) is what is going to happen to the Chinese demand spike and global supply. Last year’s super-aggressive Chinese stimulus credit pump into property and infrastructure is retrenching at record pace:
Will it be offset by some reopening of other economies in some measure? Yes. But not enough.
In terms of individual commodities, Goldman is even more bearish than I am on iron ore. So its scarcity argument does not apply there, apparently. Rightly, supply is rebounding all over the place: Australia, Brazil, Africa, India and China.
Yet how is this different to copper? Global fiscal stimulus and catch-up growth, led by China, has temporarily supercharged demand while COVID has delivered short-term bottlenecks in copper too, which will normalise.
Oil is a manipulated market so why does it even enter this argument? All we need to know on that front is what OPEC and US shale are going to do. The former will reopen and the latter re-pump. Simples.
Over the long run, Goldman’s vainglorious thesis of a Western commodity demand revival swamping Chinese slowing could play out. Who knows?
But let’s not mince words. If Chinese consumption stalls, let alone falls which is what is coming at the moment, then the Western demand surge will need to be HUMUNGOUS and URGENT to support current commodity prices:
Looks to me like the Squid wants to dump its commodity longs on you.