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China and the global decline in base metals demand
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China and the global decline in base metals demand

Lionel Kruger Weekly bulletin March 2019
The rapid rise of the Chinese economy over the past 20 years has dominated the international financial landscape and ramped up commodity demand as the economy opened itself to world markets. Since joining the WTO in 2000, growth rates rose spectacularly as exports of goods and services reached unprecedented levels, peaking at approximately 40% of total GDP just before the financial crisis of 2007. The timing of China’s emergence coincided with a global move to internationalise supply chains. But closed economies can only reap the rewards of joining the free market once, and China now faces a number of challenges both domestically and internationally.
The effects of population planning

The most significant domestic challenge is atypical of an emerging economy: an aging working population, which has failed to benefit from the abolition of the one child policy in 2015. The official global replacement fertility rate according to the World Bank is just over 2%, with China coming in at about 1.5%, similar to neighbour Japan which faces an extreme demographic challenge. Furthermore, China’s one child policy, in effect from 1979 to 2015 has led to a massive imbalance between the sexes, with men outnumbering women on a significant scale. The consequences of too many males now coming of age distorts labour markets, reduces consumption spending and increases savings. These latter two consequences are the second and third most significant domestic challenges to the Chinese economy. The task of rebalancing the economy is weighing heavily on Chinese policy makers as they attempt to steer away from investment and export-led growth to one based on domestic consumption and lower savings.

Internationally, the opportunity for China to take more market share of global goods and services no longer exists at the levels enjoyed over the past two decades and in all likelihood, the internationalisation of global supply chains has now run its course. The trade war with the US could not have come at a worse time and coincides with slowing world growth both in developed and emerging economies. Official Chinese GDP has declined to 6.8% but realistically sits at around 2% lower than official figures. The economy looks set to slow further into the second half of 2019. Long-term growth is likely to decline to 2% per annum. A recent study published by the Brookings Institution, a Washington based think-tank has reinforced long-standing scepticism about official Chinese figures and argues that China’s economy is actually 12% smaller than official figures indicate.

Global markets are increasingly concerned about China’s equity market selloff and currency depreciation, with capital leaving the country at an alarming rate.

Knock-on effects for commodities

Many emerging markets are heavily reliant on trade with China and those rich in natural resources, such as South Africa, are particularly exposed to any Chinese slowdown. With China having over invested in domestic infrastructure and housing, together with declining exports, the price outlook for commodities is looking far less certain. The commodity super cycle of 2006/7 seems unlikely to be repeated anytime soon.

Base metals have started this week on the back foot again, lead lower by weak macro data out of the US on Friday. The spectre of the US-China trade war continues to depress prices, with Zinc extending its losses as stockpiles in China surged higher. Copper is currently one of the exceptions, benefiting from a weaker USD and recovering some of Friday’s losses.

News last week that China will be implementing a tax cut on April 1 saw traders pricing in lower copper forward prices, increasing the negative gap between future and spot prices. The market has now turned its attention to the BoE and Fed meetings this week, with any central bank easing likely to boost demand, and support a price recovery. While both the BoE and Fed are expected to keep rates unchanged, any shift to a more dovish rhetoric should prove sufficient to boost demand further.

For more information, please contact Lionel Kruger, Director at JCRA, at lionel.kruger@jcrauk.com.

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