For once our favorite doomsayer Ambrose Evans-Pritchard, International Business Editor of the Telegraph Newspaper is not quoting his own research in an article but that of Deutsche Bank and RBS owners of Sempra Commodities. The article quotes Michael Lewis, commodities chief at Deutsche Bank as saying, “We believe overheating risks in China are escalating, heading into the second quarter, we believe China will become the main source of event risk for commodity markets, specifically industrial metals.”
The bank believes Beijing is likely to slash growth in spending on infrastructure from 120% last year to just 7% this year. Deutsche expects China’s central bank to cut loan quotas by almost a quarter to 7.5 trillion Yuan ($1.1 trillion) this year, raise rates, and tighten reserve rules to choke inflation, while local authorities take their own measures to curb the property boom. As lead, zinc, copper, and nickel are all highly leveraged to China’s building cycle, consumption will be hit dramatically if investment is cut back as expected.
RBS is in broad agreement saying China has been the main engine of metals price increases sucking in up to 40% of the world’s consumption but more controversially it claims much of the buying was speculative and large inventory position risk still exists that have not been eaten into in spite of the high levels of industrial activity.
RBS is expecting prices to fall back over Q2 and Q3, not collapse but retrench as final consumption fails to continue its heady growth of H2 2009. The bank also warned that a surge of pent-up supply from mines is “waiting in the wings to make its grand entrance” just at the wrong moment as the global recovery goes through a patch of turbulence.
Here Mr. Evans-Pritchard comes back to a point he has made many times before but which other commentators rarely focus on and that’s money supply. An expanding money supply is a sign of growth and a contracting money supply is the reverse, certainly a contracting money supply is a severe restriction to growth. As Wikipedia puts it – there is strong empirical evidence of a direct relation between long-term price inflation and money-supply growth. According to his article, the M3 money supply has been contracting since mid-2009 in both the US and the Eurozone. It has been slowing in other areas such as Saudi Arabia, where the M3 growth rate has fallen for five months. A contracting money supply could indicate a double dip or at the least stalling growth this year.
Back to the banks. RBS is most bearish on gold, forecasting a 17% drop to $925 an ounce later this year. The metal will lose its ‘anti-dollar’ appeal as the dollar grinds higher and the Fed tightens, but shoot to fresh records above $1,300 by 2013. The bank sees parallels with the commodity rally of 1982, which faltered after nine months as the US economy tipped into a double-dip recession. Raw material prices then relapsed for another couple of years. “We expect the path ahead to be strewn with many risks associated with unwinding strategies, rising rates and taxes, and the debt burden,” it said. Deutsche Bank agrees seeing plenty of risks ahead not least a Greek default that spreads contagion, a larger bond market crisis in big industrial states, and regulatory overkill on banks. But the greatest looming danger is a Sino-American showdown over the Yuan-US Dollar exchange rate peg. As the article concludes, “Political rigidities appear to be building both within China to resist change, and within China’s trading partners -prominently the US to try to force change. This is a toxic mix.”