Friday, 18 January 2019

Swings and turnabouts

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  • Swings and turnabouts

As consumer-driven economies deepen, demand for commodities will pick up again, contrary to some who ascribe to the notion that the economic slowdown in China and India will impact on consumers and producers.

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To talk about the impact of the economic slowdown in China and India on the global commodities markets and on commodity-producing nations depends on whether one actually subscribes to the notion of a slowdown, or, like Mark Mobius, executive chairman of Templeton Emerging Markets Group, takes the view that the lower GDP numbers for these countries – China in particular – and the global effects thereof are just a temporary hiccup in what might arguably be among the greatest growth stories of all time.

Mobius said: “The question on everyone’s lips is: ‘Is China going to have a soft or hard landing? My answer is: ‘China is not landing, it’s going to keep on flying,’ so how can we talk about a slowdown when the growth in China is expected to be at least 7.5% in 2012?”

That is a far cry from the dismal growth figures projected for a developed world that is still trying to dig itself out of the deep hole into which it has fallen. More importantly, China’s growth (and India’s, to a lesser extent, since its GDP has been forecast to fall to around 6.7% for 2012–13) will, in Mobius’s opinion, lift commodity prices off their current lows and get them to trend back up over the long term.

According to Walter de Wet, head of commodities research at Standard Bank, despite the temporary slump and the sharp fall in demand for certain commodities, what was more important for the commodities market overall and for the nations that produce and export commodities was the bigger picture: the tremendous, long-term growth potential of countries like India and China. In due course, this will once again increase demand for a range of different commodities that span the gamut from energy to precious and industrial metals and everything else in between. 

“You’ve got to be able to distinguish between cyclical slowdowns and structural changes, and to know that while there may be a slowdown now, growth will pick up at some point,” said de Wet. “In the case of China in particular, the economy is rebalancing, changing from being primarily industrial-driven to consumption-driven, and while that certainly has a negative impact on certain commodities in the short term, it doesn’t mean that demand for them won’t pick up again as this shift continues.”

Of course, the shift was a work in progress, and coupled with the general economic contraction in the global economy, China – which has been the world’s greatest consumer of commodities – had reduced its demands for energy and metals, and this has had a significant impact on major commodity producers such as Australia, Brazil, Chile and Canada, said Malcolm Gissen, president of independent investment advisory firm Malcolm H. Gissen & Associates.

Certain sectors like base metals had been major underperformers, he said, their stocks also falling as they have come under some stress, and the malaise for commodities in general has been exacerbated by the slowdown in the EU economies and the slower than expected recovery in the US.

“In the case of China , the economy is rebalancing, changing from being primarily industrial-driven to consumption-driven, and while that certainly has a negative impact on certain commodities in the short term, it doesn’t mean that demand for them won’t pick up again as this shift continues”

Political risk

Some commodity sectors are also facing increased political risk. Gold mining companies from Canada and Chile, for instance, looking to explore in other parts of the world, have had a tough time getting licences as countries like Indonesia and Pakistan had suddenly become more protectionist, Gissen said.

As such, companies that had spent a great deal of money setting up mining operations in other countries, only to see them not being approved, were now reluctant to fund large capex projects, and this has had an effect on the supply of gold and other metals, he said. In an environment of reduced demand, this isn’t too much of a concern, but it could be an issue once demand starts to pick up again.

Right now, though, countries that export commodities are heavily focused on the demand slump, and nations like Brazil, which prospered in large part because of its exports to China, have had to seriously revise their growth forecasts downwards.

And yet the depth of the impact of decreased Chinese demands on Brazil and other commodity-producing nations also depends largely on individual commodities: what they are, where they’re being produced, how much it costs to produce them and the price at which they’re selling.

Iron ore, for instance, is currently priced at around US$90 per tonne, half of the US$180 per tonne it sold for a year ago and it is likely to trend lower because China has seriously cut back on its iron ore imports. However, countries like Australia and Brazil – one of the world’s largest suppliers of iron ore – were still able to produce it for a mere US$40 per tonne, so even if demand had fallen and may fall lower yet, those countries were still making money from the sale of this metal, de Wet said, even though their economies may be hurting in other ways from slowing Chinese demand.

Conversely, the fall in Chinese demand has pushed the price of copper down to around US$7,600 per tonne from US$10,000 a tonne it sold for last year. This has had a material impact on Chile, whose chief export is copper, de Wet said, since copper production costs there were around US$6,000 per tonne.

When it comes to crude oil, China only accounts for 11% of global crude oil demand (and India is even less than that, according to de Wet), a mere fraction of what the US consumes on a daily basis.

Increased demand

Even though crude oil had taken a hit because of China’s move away from manufacturing and industry, coupled with the cyclical slowdown in its economy, it was one of those commodities that would become more important again as the consumer-driven economy took root and the middle class grew, said de Wet, since “more people are going to be buying cars”.

“We can also expect the demand for other energy products like thermal coal to grow for the simple reason that as economies grow, there’s a need to expand electricity to households. And when it comes to metals, you’re going to see an increase in the kinds of metals that have to do with the consumer economy, such as aluminum, which is used in high voltage power generation lines, and in the long term, will probably be in greater demand than copper,” he said.

While coping with the short-term crunch, then, the good news for those commodity-producing countries most affected by the China slowdown is that the continued growth of the middle class in China and also India is a fait accompli, and wherever a middle class develops, there was always a need for commodities, said Gissen.

“The slowdown in China is temporary and the need for continued infrastructure spending will create increased demand for commodities in 2013,” he said. “Some economists are also predicting that the EU nations will embark on an infrastructure spending programme to generate jobs and India has said it will spend billions on infrastructure improvements.

“We see the same thing happening around the world as nations strive to improve living conditions for their people, and countries like Vietnam, Indonesia, Turkey, and even some African nations are also creating demand for commodities, since the need for infrastructure spending is enormous in these nations, especially in the development of power.”

Gissen also believes that the longer-term story will allow for the emergence of new commodities, such as vanadium, a metal found in North America that has been mostly used to harden steel, but can also be used in car batteries and in large batteries connected to wind and solar power.

“I think the demand for vanadium and other strategic metals will grow significantly over the next 10 years as countries seek to explore alternative energy forms,” he said. “Chinese demand can more or less dictate the market for a metal like vanadium – China has the money to invest in alternative technologies and it will invest.”

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