The sell-off in emerging markets has spilled into commodities, hitting prices of key resources from copper to oil.
But there are growing fears that it’s not just a knock-on effect of weakening currencies or a short-term speculative washout in risky assets. It could be a harbinger of weaker growth in China, the world’s largest consumer of raw materials from metals to fuels.
Traders say the worry is that lower economic growth in emerging markets, including Turkey, Brazil, Argentina and India, could quickly cool demand for commodity-intensive exports from China, the world’s biggest user of raw materials.
That comes at a time when Beijing’s efforts to cut its heavy debt load have restricted access to credit for many private companies, while a strong dollar has the additional impact of making commodities more expensive for Chinese buyers.
“A bitter cocktail of events has come together,” Mark Hansen, head of commodities trader Concord Resources, says. “People’s future demand expectations have changed materially.”
Overall, industrial metals have fallen 19 per cent from a peak in April, putting them on the cusp of a bear market, according to the Bloomberg Industrial Metals Index. Last week copper hit its lowest level since July 2017, while metals including nickel, zinc and aluminium also fell sharply.
Prices are likely to depend on whether China’s government will stimulate its economy, the world’s second largest, to counter a slowdown — especially if the brewing trade war with the US escalates.
Over the past year Beijing has clamped down on credit in its economy by restricting access to shadow banking and peer-to-peer lending, which has limited access to credit for smaller firms. It is a campaign that was backed by President Xi Jinping during a meeting of the politburo, the Communist Party’s top ruling body, on July 31.
John Browning, managing director of Hong Kong futures broker Bands Financial, says the corporate clients he speaks to are finding access to credit difficult and are “having a tough time”. Consequently, they are lowering their expectations for metal demand, which has already been reflected in heavy selling of copper futures in Shanghai.
“Selling copper is the default setting of those that have a bearish view of the [Chinese] economy,” he said. “There’s no immediate upside in copper unless there’s some supply disruptions.”
Recent attempts to loosen credit in China “haven’t done enough to improve short-term sentiment”, Concord’s Mr Hansen said. “Base metals have been the epicentre because of their sensitivity to Chinese demand.”
The weakening in emerging market currencies has an additional negative effect on commodities since it lowers the cost of production for mining companies, which could add to supply just as prices are falling.
“As you devalue currencies in emerging markets, many of which are natural resource producers, they are going to try and ramp output as they get paid in dollars for commodities,” said Doug King, manager of the $136m Merchant Commodity Fund, which is up 2 per cent so far this year. “So the currency moves both add more commodities supply while also raising a big question mark over demand.”
Still, some investors are more optimistic that China will further loosen access to credit and prop up its currency and economy. They note that the country’s vast property and construction markets remain healthy.
“It does seem somewhat overdone to us,” Neil Gregson, a fund manager at JPMorgan Asset Management, said. “Fixed asset investment and construction are picking up — which will improve the demand in China.”
Mr Gregson noted that commodities that are less frequently traded on financial markets have avoided the worst of the selling, indicating underlying strength in demand. Coal prices are trading at their highest levels in six years, while steel-related commodities such as iron ore and vanadium have also rallied.
In addition, grid and rail investment in China is likely to remain strong for the remainder of the year, Mr Gregson adds.
“A lot of the performance [of metals] is the unwind of positions on the futures exchanges, it’s a much quicker response to macro news,” Mr Gregson said. “There’s a pretty strong relationship between the dollar and copper, when people feel positive on the dollar they sell copper.”
The number of financial contracts betting on a decline in copper on the Comex exchange in New York has risen to the highest levels in 22 months.
That is a sign that hedge funds and traders have a unanimous negative view on future prices of the metal. On the flip side they remain heavily invested in oil, creating the risk of further selling if traders decide the risk to demand growth is rising.
“With emerging market currencies currently moving in one direction,” Mr King at the Merchant fund said, “you probably don’t want to be the one trying to catch the knife.”
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