LORD COPPER: The Chinese slowdown that will deepen the trough

The slowing down of Chinese economic growth, while probably predictable – nothing goes in one direction for ever – looks as though it may pose some severe problems for the producers and traders of hard commodities.

The slowing down of Chinese economic growth, while probably predictable – nothing goes in one direction for ever – looks as though it may pose some severe problems for the producers and traders of hard commodities.

Iron ore and coal prices have continued their decline, with negative effects on the profitability of the major miners. That decline has been caused in large part by the fall in Chinese steel demand; the dangerous potential knock-on effect of which is that steel-backed loans will fall further and further underwater, provoking forced sales into an already weak market.

We all know what that does to prices.

Copper, it seems to me, is struggling to hold its current levels, and rallies are largely the products of an irrational belief in the dubious power of governmental economic stimulus – dubious because it hasn’t yet set the world alight, despite a few years now of trying – and I already expressed my surprise at Rusal’s confidence that aluminium prices would recover to $2,400 “very soon” a month and a half ago.

Oil is bucking the trend of softness for the moment, but it’s always a more political animal than the other industrial commodities, and events in the Middle East are undoubtedly giving support to that market.

So the picture for metals looks rather bleak. Is it reasonable to attribute all of this to China?

Well, really, I think the answer to that is yes and no.

No, it’s not, if you take a rational view; China is the growing powerhouse, but it can’t yet be expected to be the engine of the whole global economy. That won’t happen for a while, realistically until it transforms itself from a manufacturing-for-export economy to a balanced consumer one.

Why there is an element of “yes” in the answer is because of the excessive expectations that have been forced onto China – all those optimistic desires to see China rescue the rest of the world.

Unfortunately, I have a suspicion that demand falls caused by a slowing in the rate of Chinese growth (as evidenced by Chinese copper stocks rising to nearly 1 million tonnes) will have a disproportionate effect on prices. In other words, because the rally was over-hyped, the trough will be deeper than it would otherwise need to be. Simple market momentum, really.

It’s not yet entirely the turn of China and the rest of the BRICs. It will undoubtedly come, but for a recovery now, we need to see Europe and, particularly, the USA begin to show genuine re-strengthening of their economies. That will be difficult in the face of the continuing soap opera of the euro, where politicians and bureaucrats continue to assume they know better than the economists how to resolve the crisis.

Now, through the first decade of this century, we heard an awful lot about the new paradigm and the super-cycle in metal and mineral demand. Actually, all that meant was that the artificial environment created by relatively low interest rates and unfettered public and private sector borrowing on the one hand, and years of under-investment in mineral development in previous decades on the other, fuelled a stimulation of demand and a corresponding surge in prices.

I think where we are now is at the early stages of reversing part of the circle, and far from the continuing strength in commodity prices predicted by some forecasters, I expect to see a decline. What would be disappointing in those circumstances would be to see a reduction in project development by the mining houses, leading back to the boom and bust cycle. Disappointing, but I suspect only too likely, as aligning supply and demand in the extractive industries has never been an easy task.

So where does that rather gloomy picture leave the commodity investor?

Well, look beyond metals, would be my suggestion. I have a feeling we are going to see continuing strength in the softs, and that’s probably where the smart money is going.

Lord Copper

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