Portfolio

China can make or break it

Rajalakshmi Nirmal | Updated on March 10, 2018

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Calling it a bottom now is risky, but gold and agri-commodities may do better

Commodity prices fell like ninepins in 2015 on an economic slowdown in China, and the resultant glut in the market.

China, which was consuming about half of the global output in metals for many years, saw growth falter. From an average of 9.5 per cent in 2012 and 7.4 per cent in 2014, the country’s GDP growth dropped to 6.9 per cent in the July-September period of 2015. Both imports and exports dropped and the dragon economy’s appetite for industrial inputs fell, resulting in ample supply of commodities in the global market. This set off a sharp correction in commodity prices.

However, the output of a host of commodities, including oil, coal, iron ore and copper continued to grow as producer countries benefited from a weak domestic currency. Emerging market currencies saw a steep correction against the dollar, as the latter gained muscle from a stronger US economy and expectations of a rate hike. The US dollar index cut the 100-mark in the year. The last straw was China’s market-linking of yuan in August. A 2 per cent correction in the currency as a reaction to the move brought forth another bout of decline in commodities on fears of a further drop in Chinese imports.

Will the rout in commodities stop in 2016 and offer a breather to prices?

Only China can answer.

The superlative growth in China in the last decade was funded by debt. Now that the country is mending its ways and bringing in fiscal reforms to shift from a manufacturing-led to a consumer-led economy, it is unable to continue growing at double-digit rates. With excess capacity of 30 per cent plus in many commodities, including steel, aluminium, iron and power equipment, the only way out for China now is to push its industries to export more. Given a weaker yuan, Chinese exporters will also now have a competitive edge. But again, this is not good for commodity prices, as this will only worsen the glut in the global market. Industrial commodity prices can recover in the New Year only if Beijing chalks out focussed measures to revive its economy.

Oil, precious metals

Another commodity where outlook is clouded by expectations of a supply glut is oil.

Despite prices plummeting to $37 now from $128/barrel in 2012, OPEC is refusing to cut production. If sanctions on Iran are also removed in 2016, analysts expect the additional supply to well exceed the decline in production from the US shale oil industry.

The fate of precious metals will be decided by the dollar. In the past, when the US hiked rates, the dollar has moved lower. If this happens again, it will bring back the safe-haven demand for the yellow metal. This can help gold get back its mojo and target $1,200-1,250/ounce levels.

Agri-commodities may actually be a winner in 2016. If El Nino intensifies, it may hit agriculture yields in East Asia and parts of America and South Africa which export rice, palm oil, sugar and cocoa.

There is ample supply of grains, wheat and oil seeds in the global market, but still, local markets in developing countries of Asia may see supply disruptions and price inflation, given their isolation from global markets.

Published on December 27, 2015

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