IEZ - Is China Economic Weakness Putting A Ceiling On Commodity Prices?

2023-08-17 12:22:00 ET

Summary

• China's economy has not met post-lockdown growth expectations.
• That slowdown has had a mixed impact on commodities demand.
• China's government may need to step in with more stimulus.

As China's economy struggles to find momentum, is there a ceiling being put on commodity prices? MoneyTalk's Greg Bonnell discusses with Daniel Ghali, Senior Commodity Strategist with TD Securities.

Transcript

Greg Bonnell: China is hinting that more stimulus may be on the way as its economy fails to live up to post-lockdown expectations. But will that give a lift to the commodities space? Joining us now to discuss, Daniel Ghali, Senior Commodities Strategist with TD Securities. Daniel, great to have you back on the program.

Daniel Ghali: Yeah, thank you very much for having me.

Greg Bonnell: It seems like every day, we get another weak economic data point out of China, after all of the hype at the beginning of this year about how that reopening was going to fuel their appetite for everything. Well, what's going on there?

Daniel Ghali: Yeah, you know, it's funny. It's not only the reopening that fueled optimism, but if we were to have this discussion a month ago, there was an immense amount of optimism surrounding the property sector. Obviously, that hasn't panned out. The situation in China is actually pretty dire. If you look at the trade data that came out earlier this week, it was pretty negative -- exports down 14%, imports down 12%. That tells you that both external demand from China is declining, and domestic demand is pretty bad.

Now, the more concerning aspect to me is on the property sector side of the equation. We've seen hopes that earlier in the year, that the reopening was going to turn the property sector over. The Chinese government bailed on a lot of the restrictions for property developers' financing, so that hope was perhaps warranted. But instead, what we've seen is right after the reopening, the property sector has started to slump again. And this is concerning because it might be pointing to structural issues that might turn the economic problem into a liquidity problem.

Greg Bonnell: Now, that's a pretty big issue, obviously. Earlier this week, in the middle of all this weak data, we did get a rate cut from China's central bank. And then there was some reports today out of state media in China saying, at a cabinet meeting, the government said, yeah, we need to do something along the lines of stimulus, but pretty vague. I mean, what can China do at this point? That rate cut seem to completely over -- underwhelm, I should say, the market.

Daniel Ghali: Yeah, no, absolutely. I mean, from the monetary policy perspective, China's in a tough situation, because the currency is depreciating at a fast pace. But they do need to stimulate. The most important part of the July Politburo meeting was the omission of President Xi's mantra that houses are for living, not for speculating. That raised the hopes that there was going to be a turnaround in property sector policies.

And we have seen some hints of what might be coming, but overwhelmingly, the stimulus that is being talked about is extremely targeted in nature, as opposed to the broad-based type stimulus that saved the global economy in 2015 and in 2008. That's the big question for markets. How exactly are they going to stimulate? And so far, it doesn't look like it is the big stimulus that people are hoping for.

Greg Bonnell: When we think about all the excitement earlier in the year about China's economic reopening and then more recently, as you said, the hopes for some sort of stimulus, was that more on the Western world than China? I mean, did we start to sell ourselves some hype about what China could provide?

Daniel Ghali: Yeah, I think, absolutely. Our research suggests that the hype around the Chinese property sector stimulus and the Chinese stimulus overall has overwhelmingly been driven by the West. We say that because in the aftermath of that July Politburo meeting, we had the highest inflows into Chinese -- foreign inflows into Chinese equities on record.

We also saw commodities -- copper, other industrial metals rally sharply. And our research suggested that those speculative flows were coming from the West, whereas our tracking of Chinese trader positioning suggested that they were heavily offloading in the aftermath of the July Politburo meeting, and that definitely raised some red flags for caution.

Greg Bonnell: Okay, so that's a very fascinating dynamic -- your mention of the inflows and the commodities from the West. If this is now the backdrop for China, and we don't know what they're going to do -- and you said they're in a pretty tough place in terms of trying to get the economy turned around -- what does it mean for commodities?

Daniel Ghali: Well, obviously, China is, by far, the largest consumer of commodities. So anything that is detrimental to the Chinese economy is bad for the demand side of commodities. I'll caveat, however, that since China's reopening, we've seen the demand for commodities diverge.

Raw materials like copper, aluminum, zinc, et cetera, their demand is subsiding at a pretty notable pace, whereas for the energy sector, we've actually seen a boom, a recovery, in China's demand that really has been driven by more international travel, more flights. As you'd expect, the pent-up demand for travel in China was pretty significant during the lockdowns, and in turn, that's been driving a lot of the demand side of the equation for the energy complex this year.

Greg Bonnell: If we can't count on Chinese saying -- it is nuanced, right? I mean, you've got the domestic travel. You have a need for fuel and jet fuel. But if we can't count on them to be the save-all for all these commodities, what do we need to start thinking about?

Daniel Ghali: So there's a few things that we're thinking about in terms of risks. The first we touched upon earlier is China's property sector issues morphing into a liquidity issue. And we say that because recently, there have been some trust companies that's -- the shadow banking sector in China that have missed some payments. The concern here is that shadow banks' payment failures are going to seep into local government financing vehicles.

That concern is exacerbated by the fact that local governments typically finance themselves with land sales, but land sales are down 50% year-on-year. That's a demand-side issue. People don't want to buy more land. They don't want to buy -- to build more projects. The focus is on completing the projects that are already being in construction, as opposed to the pipeline for future projects. And that is a big concern for local government financing.

Greg Bonnell: So real challenges here in China for their economy. You've laid them out nicely for us. What is the upside potential here for China? What could go right?

Daniel Ghali: Well, our economists do expect a fiscal package to be announced, hopefully before September. That should have the largest multiplier effect on the Chinese economy as a whole. But again, what is happening in China is a bifurcation between the old sector industries and the new sector industries that the government actually does want to promote. So more likely than not, that fiscal stimulus is going to be targeted to bolster consumption in the areas China actually wants to bolster consumption in -- namely, new energy vehicles, for example, and that does have an implication for commodities.

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