Time to jump from commodity wagon?
Has the commodities cycle peaked? Perhaps, argue some. The analysts at SG, for example, describe how the Chinese authorities have been trying to restrain bank lending, by imposing curbs on loan approvals. They go on to suggest that these attempts are succeeding given that Chinese money supply growth has slowed. This could be taken to indicate that monthly lending by the banks is being cut back which would be a drag on capital expenditure and on demand for raw industrial goods in general. They point to the fact that the Baltic Dry Freight Index, which measures the cost of chartering a ship to carry dry, loose freight, as already rolled over indicating fewer bottlenecks in shipping raw materials.
And Graham Turner of GFC Economics thinks commodity markets are right to be nervous of just how far the Chinese authorities will go to secure a slowdown in bank lending and cautions against too much optimism that the slowdown would be gentle. “Only time will tell if Beijing can achieve the ‘soft landing’ that seems to have eluded so many other countries swept along by similar credit bubbles in recent years,” he warns.
But others think these concerns are exaggerated and believe that the Chinese authorities have adjusted policy early enough to prevent a hard landing. Indeed Morgan Stanley give the Chinese ‘hard landing’ scenario only a 15% probability. Their baseline does assume a significant slowdown in economic growth in China – but it would be a ‘soft landing’ and in that scenario demand for commodities and energy should remain strong.
But SG see differences in this current rising commodities prices cycle, principally because, unlike in previous cycles, the surge in demand for commodities has come from emerging Asia rather than the developed world. The investment boom in China has drawn in more and more commodities, and huge amounts of raw materials have been needed for soaring capital expenditure in China and emerging Asia. The statistics are amazing: Chinese total investment has doubled in three years; construction investment has trebled!
SG argues that, if policy is indeed being enforced to restrain capital expenditure in China, then one of the main pillars of global demand is under threat. They have developed a rather unconventional, but interesting tool to aid their analysis: They believe that there is a link between the proportion of news stories which focus on economic strength and actual economic demand. “Strong global economic demand is reflected in the newsflow of economic stories. 73% of all economic stories are, at present, describing economic strength, up from a low of just 32% back in 2001. Unsurprisingly, global industrial production has surged over this time and is now growing at the fasted pace seen in recent years.
“The newsflow of economic stories is a fantastic real-time indicator of global economic demand, and we believe it (the newsflow) is approaching a peak.” They sum up by recommending that investors now underweight commodity plays. Graham Turner agrees and suggests the correction in commodity-related currencies such as the Australian, Canadian and New Zealand Dollars, may accelerate in the coming months.