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Commodities slump on China tremors and OPEC failure
Brent oil prices have plunged to a five-month low beneath $50 a barrel and industrial metal prices have suffered the biggest one-day fall this year on fears of a supply glut, tipping the commodity nexus into a bear market.
Iron ore crashed by its maximum trading limit in Dalian and steel dropped 6pc in Shanghai, suggesting that China’s economy may be slowing more sharply than widely assumed in the West as regulators tighten credit and investment projects are shelved.
The IHS Materials Price Index has fallen by 10.3pc since peaking in mid-February and has given up all the gains since the election of US President Donald Trump, closing the chapter on the dying reflation rally.
IHS economist Cole Hassay said credit curbs in China and rising interest rates in the US are clearly taking their toll.
The index captures range of goods such as lumber, rubber, and fibres, as well as metals and energy, making it a useful tool for gauging the health of the global economy. The Baltic Dry Index measuring freight rates for dry goods has fallen by 30pc over the same period
“It is the growth-dependent commodities like industrial metals that have really had the biggest problem over the last 48 hours, and that is all because of softer data out of China,” said Ole Hansen from Saxo Bank.
“The spending on infrastructure in 2016 is starting to fade, and banks are raising lending rates,” he said. Both the Caixin manufacturing index and the IHS Markit survey for services both fell back to 2016 levels in April after a boom over the winter months.
The global commodity rout is a complex mix of supply and demand pressures, making it hard to draw clear conclusions.
The trigger for Thursday’s 4.8pc dive in Brent prices to $48.35 was a report from the US Energy Department showing a painfully-slow fall in oil inventories, accompanied by a rise in American output to almost 9.3 million barrels per day (b/d).
US production has risen by 800,000 b/d since the trough last year as super-efficient shale drillers continue to expand in the prolific Permian basin, with the US rig-count more than doubling to 870. A surge in Libya’s output to a two-year high of 760,000 b/d has compounded fears that it will take far longer than first thought for OPEC to clear the glut.
The Abu Dhabi Investment Authority warns that prices could fall back to $40 if the cartel and Russian-led group of non-OPEC producers fails to extend their agreed production curb of 1.2m b/d when the deal expires in June.
It could be even be worse if hedge funds join the chase. “There are signs that ‘speculative longs’ are throwing in the towel. God help the market if there is no deal,” said Mr Hansen.
Yet surging supply is only part of the energy story. Consumption in the rich OECD bloc fell by 0.4pc in February from a year earlier, and it has been lacklustre in emerging markets.
“Oil demand growth is very poor,” said Dan Smith from Oxford Economics.
The picture of soggy demand is even clearer for industrial metals. Iron ore has crashed by over 30pc as stockpiles reach record levels in Chinese ports and steel mills suspend production. China accounts for half the world demand for iron ore, copper, and zinc, among other metals.
It is now clear that the credit squeeze by the People’s Bank is starting to bite. Regulators have launched a crack-down on the wealth management products and other parts of the $8 trillion shadow banking system.
Three-month Shibor lending rates have almost doubled to 4.35pc since November. Caixin magazine reports that Chinese companies cancelled $20bn of bonds and short-term debt issues in April because of tightening market liquidity.
“Investors should be cautious about downward risks in the economy,” said Zhong Zhenhgsheng from the CEMB Group.
Bo Zhuang from TS Lombard said the growth cycle for nominal GDP has already rolled over in China after peaking in the first quarter. The boom last year was driven by a drastic decline in real interest rates from asphyxiating levels of 10pc to the other extreme of minus 3pc. This is now reversing.
Real rates have spiked back up to 3.4pc, closing the vice on an economy with corporate debt at record levels above 170pc of GDP.
“This is not being closely assessed by investors. We are a lot more pessimistic than the market,” he said.
At the same time, property curbs are becoming stricter. The PBOC is restricting total mortgage credit to 30pc of all loans, down from 45pc last year. “We think we could see falls in house sales of 15pc or 20pc in the second half,” he said.
Capital Economics says the minimum down-payment for a large house in Beijing and Shanghai is now 80pc, and 60pc for small homes.
This regulatory squeeze is happening at a time when the backlog of unsold property has reached 15 million - 12 months’ supply - and financing costs for struggling developers is surging. The slowdown in construction has already begun and it is unlikely to be smooth.
The question is whether this is just another cyclical dip in China’s hallmark stop-go pattern of economic management, or the start of a deeper problem stemming from credit exhaustion.
What seems scarcely in doubt is that commodities are signalling the end of the great Chinese reflation boom.