China slowdown key factor to more sideway moves in iron ore and copper prices

PUBLISHED : Sunday, 06 November, 2016, 8:32pm
UPDATED : Monday, 07 November, 2016, 10:10am

Prices of iron ore and copper, two base metals whose consumption in China are world leading, are set to trade sideways for longer as demand growth from the increasingly indebted nation is insufficient to lift prices amid rising supply, analysts say.

Erik Norland, executive director and senior economist of CME Group, a global operator of marketplaces for financial derivatives on products including energy and metals, said China’s slowing economic growth on the back of a rising debt burden is a factor.

“When debt levels are low, accumulating additional credit adds quickly to gross domestic product,” he said. “When debt levels become relatively high, however, additional borrowing adds little to GDP as the new loans serve mainly to refinance existing debt.”

After rallying 70 per cent between December 2015 and April this year, iron ore joined copper in trading sideways.

Both suffered gruelling bear markets after peaking late 2010 and early 2011 following Beijing’s four trillion yuan economic stimulus package in 2009 that featured heavy infrastructure investment led by local governments.

Iron ore was the harder hit of the two, trading at about a third of its peak value, while copper is trading just below half its peak levels, Norland noted.

Iron ore mining supply has tripled since 2002, while copper mining supply has risen by only 37.5 per cent over the same period, leaving a vastly oversupplied iron ore market while copper is less so.

“The [recent] sideways price action might be telling us that China’s economic growth rate is, in fact, not rebounding very much even in the face of stimulus measures designed to boost growth,” he said.

“Accelerating the pace of debt accumulation could stabilise the growth rate in the short term, but only at a long-term cost of a potentially deeper economic downturn or longer period of slow growth ... American, European and Japanese officials have found that fiscal and monetary stimulus are less effective with high levels of debt.”

China’s total debt-to-GDP ratio may rise to 264 per cent by the end of the year, from 251.6 per cent a year earlier, Citi’s economists estimated.

Beijing has allowed banks to substantially increase their home mortgage lending this year, which led to a home sales boom that saw prices surge over 30 per cent in some big cities and helped reduce high housing stock in smaller ones.

It has also approved greater infrastructure investment to help steady declining economic growth, which also requires debt financing.

Power transmission infrastructure that made up about 36 per cent of the nation’s copper demand last year, surged 31.6 per cent year on year to 356.6 billion yuan according to industry regulator the National Development and Reform Commission.

“But it is not sufficient to support global copper price very much in light of rising supply,” Norland said. China consumes about 40 per cent of the world’s copper supply and about half its iron ore.

According to an estimate in March by Gavin Montgomery, director of global metals markets research at London-based Wood Mackenzie, China’s economic growth target of 6.5 per cent for the five years to 2020 would support annual copper consumption growth of just over 2 per cent.

While year-on-year infrastructure investment growth has picked up from about 17 per cent early this year to about 21 per cent in September, fixed-asset investment in manufacturing slid from 8 per cent to 3 per cent and that of real estate has resumed a decline trend after a spike in the first quarter.

Construction accounts for about a quarter of China’s copper demand and about half its steel consumption.

Norland expects iron ore and copper prices to trade sideways for longer due to ample new supply and slower global demand growth than during the boom years before 2013.

For copper, Norland noted slow pickup in new house construction in the United States and a “very weak” housing market in Europe meant rising demand from China can only barely mop up the new supply coming from new mining capacity.

New house construction in the US, while growing in single-digit percentages in recent years, amounts to only a third of the peak in 2005, partly due to first-time buyers’ getting married later and dimmer income growth prospects, he added.

This was not helped by the fact that Europe is only in an early stage of economic recovery, and emerging markets like Russia, Brazil and Saudi Arabia have been cutting back on building construction due to sharp economic slowdowns or recessions.

ANZ senior commodity strategist Daniel Hynes shared Norland’s view on the price of copper.

“In the short term, copper prices are likely to be capped on the upside as the market weathers a short-term pick up in output,” said he said in a report late last month.

New projects in Peru continued to push global mine supply higher and growth in output hit 9 per cent year-on-year earlier this year, he noted, although it is expected to slow given most of the new mines are near the end of their commissioning phase.

This story has been amended to correct the spelling of CME economist’s name