As one of the largest economies in the world, China’s success or failure impacts the entire global economic infrastructure. After more than a decade of outstanding double digit GDP growth figures, China has finally begun the long wind-down from those unsustainable highs to settle into a more stable and conservative growth rate. This year, annual GDP growth is expected to be around 7% – down from 7.4% in 2014 and 7.7% in 2013 – marking it as the slowest expansion in 25 years.
The Commodities Super Cycle
Emerging markets are usually fueled by manufacturing growth, with high demand for energy and materials giving them a strong correlation with commodity prices. This relationship can be seen more clearly if we track commodity performance alongside the economic slowdown we’ve seen in China over the past several years.
The collapse of the 2002-2012 commodities “super cycle” appears to be highly correlated with slowing Chinese demand. During the period, China experienced annual GDP growth that averaged 10.6% and became a major importer of commodities which helped drive prices higher.
We can take a look at how commodities have performed lately by tracking the S&P GSCI Commodity Index (GTX).
The collapse of global oil prices is clearly referenced in the chart starting in the summer of 2014 and lasting up until early in 2015. From there, commodities started to recover slightly before dropping once again over the past month. The stock market crash in China is having a huge negative influence on virtually all commodities as Chinese demand for raw materials has helped stimulate other emerging economies as well. The symbiotic relationship means that a fall in China will trickle down and damage other growing economies that are dependent upon Chinese demand.
As the world’s leading consumer of industrial metals, China has a huge influence on worldwide steel prices. The World Steel Association predicts than Chinese steel demand will fall again this year to 2.8%, down from 3.3% in 2014. It would mark the first annual contraction since 1995.
Demand will likely drop even more for next year as well since China’s economy continues to expand more slowly and the government focuses more on real estate and other financial concerns rather than expansion. The country is the world’s largest iron ore purchaser and accounts for more than half of global steel output, meaning that steel could be undergoing a correctional phase for several years.
Iron ore prices have tanked over the past year thanks to a combination of China’s lack of demand and a sudden spike in low-cost supply in Australia. Chinese steel output will shrink until 2019, although the new economic boom in Europe could help alleviate some of the pain in the industry. Demand in the U.S. is holding steady while European demand is rising which could help offset the decline in China.
Nearly 70% of China’s energy usage comes from coal, which means that the economic slowdown hasn’t been kind to the coal industry. Coal demand fell 2.3% in 2014 while coal production and imports slipped by 2.1% and 9% respectively.
A global slowdown in 2014 contributed to a coal supply glut, causing prices to drop to a five-year low while Chinese environmental concerns continue to plague the coal market. An expected increase in seasonal demand hasn’t been enough to lift coal imports this year, with year-to-date imports down more than 38%. For May, coal imports were down over 40% year-over-year.
Coal consumption in China is expected to fall 5% this year due to the slowing economy. Combined with the fact that Chinese coal production has become cheaper than importing coal and a long-term plan to decrease coal reliance and support green energy efforts, coal producers face a painful road ahead.
Copper is one of the most economically sensitive commodities. Its long standing role as an economic indicator has even given it the nickname “Dr. Copper.” It takes just one look at the chart for copper right now to see that it doesn’t bode well for the global economy.
Copper has declined quickly, sinking under six-year lows and reflecting the panic recently seen in the Chinese stock market. If we look at Peru, a country where copper accounts for 20% of its total exports, we can see the rise and fall of copper. During the super cycle, copper was in high demand by China and other emerging economies and Peru experienced growth in excess of 7%. However, since 2013, Peru’s annual GDP growth has fallen from 7% to just 1% today.
It’s a sobering reality that China’s economic boom was the primary supporter of copper prices. Thanks to years of high demand, copper producers ramped up output, which has now created a supply glut, just as China’s copper demand wanes.
The Commodity-Based Recession
China’s slowdown isn’t a temporary issue – it’s adjusting to a new growth paradigm and settling into something more reasonable for the long term. Unfortunately, the global economy has invested on the coattails of China and is now facing a sustained recession in commodity prices as supply gluts and lowered demand drag prices lower. Even gold seems unable to escape the pressure as investors flee the precious metal thanks to the lack of Chinese demand. The only support commodities are likely to get will stem from the European recovery. Although whether it will be enough to counteract China’s impact remains to be seen.
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