Being right too early is as bad as being wrong

Infrastructure investment should now lift growth, which will in turn renew demand for commodities – just a little later than predicted

PUBLISHED : Wednesday, 17 April, 2013, 12:00am
UPDATED : Wednesday, 17 April, 2013, 5:36am

I was wrong, badly wrong.

Back in February this column looked at the prospects for commodity markets in 2013.

With prices down, and major mining companies announcing losses, I examined the arguments that prices had further to fall.

And I dismissed them. My reasoning was simple, neat and - as it has turned out - completely and utterly wrong.

"Resource bulls shouldn't be too downhearted about the prospects for commodity markets this year," I concluded. "Don't write investments in the sector off just yet."

Since then almost every commodity you can think of has plunged in price. Wheat has fallen 7 per cent. Copper is down by 11 per cent. Brent blend crude oil has slumped 14 per cent. And rubber futures have tumbled 26 per cent, with the biggest falls taking place in the last few days (see the first chart).

In attempting to explain the slide, most analysts have cited exactly the same arguments I dismissed so blithely two months ago.

The most powerful explanation is that China's demand for commodities is weakening as the economy shifts to a lower growth trajectory.

As I put it back in February: "With the new leadership in Beijing promising to switch to a development model that relies less on big investment projects and more on household consumption, growing numbers of commodity sceptics are warning that China's future demand for resources is likely to be subdued compared with the heady growth of recent years."

Coming at a time when heavy investments are bringing new sources of commodities to the market, any softening of Chinese demand would be likely to hammer prices, warned the bears.

In turn, falling prices would prompt financial investors to get out of commodity markets, exacerbating the slump.

And that's pretty much what we've seen over the last couple of months: weak growth in China leading to soft demand for commodities and a mass exit from the market, propelling a vicious fall in prices.

Clearly the bull case that I found so convincing was wrong.

In a nutshell, I looked at the recent expansion in Chinese credit, and argued that - as in the past - surging credit growth would lift commodity prices.

"Commodity demand is powered by a combination of investment and speculation. And both are driven by credit. When credit is freely available, local governments and state-backed companies embark on orgies of resource-intensive investment, while speculators stockpile commodities," I argued.

Citing copper as an example, I pointed to past episodes in which an expansion in Beijing's broad "total social financing" measure of credit had driven a rise in the international price of copper some six months later.

But although total social financing has surged in recent months, the increase hasn't been reflected either in a pick-up in China's growth, or in a recovery in demand for commodities (see the second chart).

This lack of response is puzzling. But not everyone is dismayed. In a research note published yesterday, economists at HSBC argued that it is only a matter of time.

"Credit is a leading indicator, and it normally takes three to six months for new lending to turn into output," they explained. "This lag is one of the main reasons that we expect growth to pick up in the coming quarters."

They expect an increase in capital-intensive infrastructure investment in China to lift growth over the coming months.

If they are right, the fresh round of investment in railways and metro systems will generate renewed demand for industrial commodities, which should help support prices into the second half of the year.

But that will be no consolation to anyone who was long commodities over the last couple of months.

Being right too early is just as bad as being wrong.