home Latest News Why a China slowdown isn't worrying commodity investors – The Australian Financial Review

Why a China slowdown isn't worrying commodity investors – The Australian Financial Review

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Chinese President Xi Jinping is expected to sharpen his grip on power next month and wouldn’t want any economic mishaps before it.

By rights, the latest signs that Beijing’s crackdown on the risky shadow banking sector is causing the Chinese industrial engine to brake sharply should have sent tremors through global commodity markets.

Instead, investors are remaining resolutely optimistic that Beijing will ensure economic activity remains buoyant enough to avoid a commodity crash.

Figures released on Thursday show that value-added industrial output – a rough measure of Chinese economic growth – slowed for a second straight month, rising 6 per cent in August from a year earlier, after July’s 6.4 per cent increase. This represents the slowest pace this year.

Economists – who had tipped 6.6 per cent growth in August – blamed the slower growth on Beijing’s clampdown on its massive $US9 trillion ($11.25 trillion) shadow banking sector, which had squeezed credit and pushed up borrowing costs for highly indebted firms unable to borrow from state-owned banks.

They warned that Beijing’s emphasis on financial stability meant Chinese regulators were unlikely to reduce their efforts to rein in shadow banking. And this suggests that Chinese economic activity, after peaking in the first half of the year with 6.9 per cent growth, is likely to weaken further into year-end.

Even more alarming, infrastructure investment slipped to show 11 per cent growth year over year, down from nearly 16 per cent in July – a concern for investors given that infrastructure is a big driver of commodity demand.

But the disappointing Chinese growth figures only caused a ripple – rather than a rout – in commodity markets.

The price for benchmark 62 per cent content iron ore fell 3.4 per cent to $73.99 a tonne, while the price of copper – which is used extensively in construction and manufacturing – closed down 0.8 per cent in New York trading. Aluminium, nickel and zinc also traded lower.

And analysts argued the pull-back in commodity prices was a necessary correction after their latest breathtaking rally.

The price of iron ore has soared more than 45 per cent from its June low to its peak earlier this month. Similarly, the LME index, a gauge of major metals trading on the London Metal Exchange, climbed just over 20 per cent between the end of May and early September as hedge funds piled into metals, encouraged by the weaker US dollar and the brightening outlook for the Chinese economy.

Why are investors so optimistic?

So why are commodity markets shrugging off signs the Chinese economy is cooling?

One reason is that investors expect Chinese demand for iron ore and coal to remain robust given that output from China’s massive steel industry hit a fresh monthly record in August, as mills ramped up production to take advantage of steel prices that have climbed to a six-year high.

China’s old-economy steel industry is booming even as Beijing is trying to combat overcapacity. Closures of induction furnaces resulted in a shortage of reinforcement bar, a basic product used in construction. In turn, this lifted prices (rebar prices have risen 30 per cent this year) and attracted the attention of speculators.

Commodity traders were also cheered to see that Chinese real estate investment rebounded in August, showing 7.8 per cent growth from the same time a year ago, a major improvement on July’s tepid 4.8 per cent growth.

This is a welcome sign both for Chinese economic growth, and the country’s demand for commodities. Analysts estimate that real estate and construction accounts for as much as 30 per cent of Chinese GDP, when indirect benefits to other sectors – such as steel and cement – are included.

The third reason for optimism is the political calendar. The Chinese Communist Party will hold its once-every-five-years leadership reshuffle in October. Chinese President Xi Jinping is expected to use the meeting to consolidate his grip on power, and will certainly not want any economic mishaps – such as a sharp deceleration in Chinese economic activity that would roil commodity markets – to interfere with his plans for installing his allies in key leadership positions.