With the Chinese renminbi gradually appreciating for the last two years, the financial interest rate arbitrage scheme (which we explained in Part One here) also made a profit on the currency, but the People’s Bank of China (PBOC) recently put the currency into a tailspin, depreciating it for the last two weeks and sending a strong signal to the markets that such practices will not be tolerated.
Despite these fears, factory output still grew for the first two months – taken as a whole, up 8.6% – admittedly the weakest since 2009 and down from 9.7% in December, but still strongly positive. Retail sales were also slower, down form 13.6% in December, but at 11.8% still relatively strong.
Worries persist, though, as PMI numbers remain below 50, suggesting anticipation of contraction in growth. January was at 49.5 and February at 48.5, the third straight monthly fall.
Bet On or Short China?
Chinese growth and future metals demand may not be the solid bet it was a couple of years ago, but the market can’t say it didn’t see this coming.
The reaction in terms of prices for commodities and equities is probably going to be overdone, but probably still has some way to run. So far, price falls have been more to do with investor sentiment; inventory hasn’t been liquidated en masse, nor have re-exports emerged as a significant force – if they were to do so, prices could fall further.
But it wouldn’t take much of a shift by the PBOC and an uptick in metal off-take as the traditionally stronger copper buying season starts next quarter for sentiment to stabilize, at least for copper. Some European consumers are not taking the risk, taking advantage of the strongest Euro-Dollar exchange rate for 2.1/2 years and dollar copper prices down to $6,400 per metric ton some automotive and industrial consumers in Europe are in the process of locking in prices through 2017 and even 2018 according to Reuters.
Iron ore is another matter. Steel production is under pressure from a number of quarters – financial constraints on bank lending, pollution policy by Beijing and not least a weak finished steel market. Where all that inventory is going to go is harder to see; there isn’t a ready re-export market for it, so it is likely to depress future demand for many months to come.
Not surprisingly, prices have fallen and could well fall further. Australian producers remain profitable at prices well below current levels, but domestic Chinese producers will be struggling at current numbers. Possibly the work-down of inventory will be accompanied more by pain among domestic suppliers than overseas.