Can the world consume a commodities flood?
Are we witnessing a global economic slump unfolding before our eyes?
In quite a massive warning sign for global growth and demand for commodities, the recent round of Chinese economic data was disappointingly weak. This disconcerting news compounded a commodity price free-fall that started last week on the back of a market reaction to downside risks to growth in the eurozone and a hint that the US federal Reserve may end its quantitative easing in the not too distant future.
Annual GDP growth in China slowed to 7.7 per cent in the March quarter, undershooting forecasts for 8 per cent annual growth and down from 7.9 per cent in the December quarter. The uptick in GDP at the end of 2012 has now been reversed.
ANZ chief economist for Greater China, Li-Gang Liu suggests somewhat disconcertingly that “the economy in the near term still faces downside risks” and that “China’s financial repression, coupled with a faster capital account liberalisation, poses a big challenge to its financial stability”.
Critically important for Australia and the commodity price cycle, annual industrial production growth in China slowed to 8.9 per cent in March, undershooting expectations, which centered on a 10 per cent rise. The only decent news was from retail spending, which rose 12.6 per cent in the year to March to be just 0.1 per cent higher than the consensus forecast of 12.6 per cent.
All up, it was disconcerting to see China, the driver of global growth, under-performing to such a significant extent.
The reaction in commodity markets was savage and the bearish price trend continued overnight in Europe and the US. The explosions near the finish line of the Boston marathon further undermined sentiment
The broad commodity price indexes were down by between 2 and 3 per cent with the Thomson Reuters/Jefferies CRB Commodity Index falling to levels just above the lows reached in the middle of 2012 when the eurozone and Greek debt crisis were at their extremes.
Among specific commodities, the West Texas Intermediate oil price fell over 3 per cent to $US88.50 a barrel; the copper price fell a little over 2 per cent while the bear market in gold gathered considerable pace dropping around 9 per cent to $US1,340 an ounce. Other commodity prices were also sharply lower.
The concern for commodity producers, especially Australia, is that this more moderate growth in demand in China and elsewhere is coming exactly when the trillions of dollars of mining investment over the past decade is yielding additional output.
In other words, the trickle of new supply of iron ore, coal, gas, copper and a range of other industrial commodities that started as the mining investment boom in Australia, Africa, South America, Russia and central Asia is turning into a flood. If global demand does not expand at a pace that keeps up with this new supply, the outlook for commodity prices looks less than rosy. There is very little commodity producers can do about it.
For Australia, the problem is compounded because the Australian dollar remains strong and frankly overvalued due to our quite fantastic triple-A economic fundamentals. The link between the terms of trade or commodity prices and the level of the Australian dollar broke down some time ago even though the dollar fell sharply in reaction to the Chinese news and other events to be holding around 1.03 at the time of writing.
International investors are still upbeat on Australia, its economy and its macroeconomic policy settings, which are underpinning the dollar at a time when it should be falling sharply.
The Reserve Bank said it is powerless to do much about it, other than set monetary policy to an easy setting to mitigate the effects on the real economy from the Australian dollar being so over-valued. The government can’t do anything about it either as it remains unquestionably committed to a floating exchange rate, as it should of course.
The dynamics are suggesting that the Reserve Bank may well need to cut interest rates yet again and soon. The recent uptick in unemployment, the low inflation climate and soggy business conditions all point to some downside economic risks ahead. The Chinese data in addition to the sharp fall in commodity prices risks exacerbating these downside risks. While an interest rate cut wouldn’t do much other than take a few more ticks off the level of the Australian dollar, it might set up the domestic economy for a period of decent growth even if commodity prices remain weak or fall further.