No China around to rescue commodities from rout of 2015
With the prices of many major commodities currently plumbing depths last seen six years ago, what are the chances of a repeat of the China-led boom that lifted resources out of the 2008 recession funk?
To answer the question it’s worth looking at what is the same and what is different about the weakness in commodity prices between 2008-09 and now, and the answer is not much is the same.
The main similarity is simply that prices are weak and have fallen precipitously in a relatively short period of time.
Brent crude fell by about 75 per cent between the all-time high in July 2008 and the low in December that year.
So far it has dropped about 52 per cent from the last year’s peak in June to the close of US$45.46 a barrel on August 21.
Benchmark London copper futures dropped about 67 per cent between July and December in 2008, and they have slumped 22 per cent since July this year to the close of $5,055 a tonne on August 21.
The wider story for copper is that it has been trending lower since the record high in February 2011, having lost about half its value since that time. Spot iron ore prices in Asia only date back to November 2008, when, in common with crude, copper, coal and many other commodities, they started climbing rapidly as the global stimulus kicked in.
Iron ore more than tripled between November 2008 and the record high $191.90 a tonne in February 2011, and have now given back all of that gain to end at $55.60 on August 21.
The rapid gains in commodity prices from the start of 2009 was largely driven by China’s stimulus spending, which sucked in huge amounts of raw materials as the country went on a building frenzy just at the time that domestic resource companies ran out capacity to meet the increased demand.
It was always likely that commodity prices would overshoot in such a heated environment, and the 2011 peaks possibly can be ascribed to market exuberance.
But the decline in prices for many commodities started accelerating in 2014, just as it became increasingly evident that China’s economic growth was slowing and changing composition.
This was largely an engineered process by Beijing, which wanted to end the reliance on polluting heavy industries and export-led manufacturing and build a more sustainable base of a consumer-driven economy.
The point of this is that China is unlikely, and most likely unable, to repeat the stimulus efforts of 2009.
While some additional spending on infrastructure is already in the pipeline, it won’t nearly match the boom seen in the years following the 2008 global recession.
The need for new infrastructure isn’t as great, local authorities are still overburdened with debt from the last stimulus, pollution is a major concern and there are question marks over whether global demand would be sufficient to absorb much increase in manufacturing exports.
This makes it unlikely that a demand-led revival is on the cards for commodities, even with the caveat that the Chinese economy is probably not in as a bad shape as the current worst fears of investors.
The other reason for thinking commodity prices aren’t on the verge of a rebound is supply.
At the start of 2009, when China started buying more and more raw materials, commodity producers were struggling to keep up.
China’s rising demand and some bullish forecasts that this would last for decades to come prompted resource companies to spend billions to boost capacity.
It’s not a lack of demand that has contributed to plunging iron ore, crude and coal prices, rather it’s markets that have moved to a structural surplus and the response of producers to continue oversupplying in the hope that their rivals will go bankrupt before they do.
Some commodities appear further along the road to rebalancing, with coal perhaps leading the pack.
It was among the first to move into structural oversupply and the price of regional benchmark thermal coal at Australia’s Newcastle Port has been dropping for four-and-a-half years, shedding some 58 per cent of its value from the post-2008 peak in January 2011 to the close of $57.77 a tonne on August 21.
But coal is down only 6.7 per cent since January 2, indicating that despite a worsening demand outlook, prices may be close to a floor.
The commodity rout of 2015 may look similar on price graphs. This time around commodities are unlikely to be rescued by stimulus-led demand growth and structural oversupply appears to have the nasty habit of hanging around for longer than would appear economically rational.