Global PMI may be signalling commodity lift-off, but wait for China
It’s mainly commodities, such as copper, with constrained supply outlooks that stand to benefit
The recent uptick in purchasing managers’ indices in China and the developed world has led to some optimism that a rebound in commodity demand and prices is just around the corner.
The global PMI for October accelerated to 51.4 from September’s 50.7, the strongest monthly gain in nearly two years. October’s reading was also the first time since March that the global PMI had moved above its three-month moving average.
Frank Holmes, the chief executive of fund manager US Global Investors, said in an article published on November 9 that this was an indicator he watched “very closely because in the past it has reliably anticipated how commodity prices might behave in later months”.
“Our own research shows that when a PMI ‘cross-above’ occurs ... it has signalled a possible spike in certain commodities, materials and energy,” Holmes said. “Three months following previous breakouts, copper had an 81 per cent probability of rising approximately 7 per cent, while crude oil jumped 7 per cent three quarters of the time.”
These are fairly strong probabilities for gains, and if realised would be welcome news for commodity producers and investors.
However, there are a few issues that suggest caution is required in assessing the outlook for commodity prices on the back of an improving manufacturing outlook.
The first is that while the global, US and euro zone PMIs are above the 50 line that separates expansion from contraction on a monthly basis, the main China PMI is not.
The official PMI, which focuses on large, state-controlled enterprises, was 49.8 in October, which was unchanged from September’s reading, and up only marginally from 49.7 in August. The improvement in the Caixin/Markit PMI, which captures more of the small and medium-sized businesses, was slightly more positive, edging up to 48.3 in October from 47.2 in September. This was the highest reading since June, but since it remained below 50, it would be a brave call to say that China’s vast factory sector has bottomed and better times are fast approaching.
Given that China is the world’s largest consumer of commodities, it’s likely that its industrial outlook is of greater importance than those of Europe and the United States.
What the PMI, and other Chinese data, such as the seven-month low in October factory output growth, appear to be showing is that growth momentum is still lacking in the world’s second-largest economy, even though there are some areas of resilience, such as retail sales.
For a surge in commodity demand to be realised, China’s PMIs will have to move above 50, and stay there for some time, a view US Global Investors’ Holmes acknowledged in his article, saying this was “crucial”.
And even if a manufacturing-led recovery for commodities does materialise in 2016, it’s likely to be quite different in nature from prior episodes, largely because of the huge overhang of supply that exists for many commodities, particularly those where China is the top buyer or producer.
This means that even stronger demand is unlikely to spark much of a rally in iron ore, coal, steel and aluminium to name a few.
Any rally in prices for these commodities will simply encourage supply back into the market, thus capping gains.
It’s mainly commodities with constrained supply outlooks that stand to benefit, with copper being a candidate should Chinese manufacturing return to strong growth.
Gains in crude oil will depend on how quickly the current surplus can be eroded, and how rapidly marginal producers can ramp up output in response to price gains.
Overall, it appears more likely that any sustained gain in global commodity demand will depend on China re-gaining momentum, and even then, increased volumes will take longer than usual to translate into higher prices.