China PMI Disappoints – What Does it Mean for Commodity Prices?

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China’s manufacturing sector really isn’t doing very well. Compared to the rest of the world that is nonsensical but compared to what we have come to expect from China it is a truism that is getting people asking what are the consequences for commodity imports in the year ahead?

Clearly the market thinks it is bad. Copper, iron ore, coal, they are all down, in large part because of the perception a slowing China will not absorb the increased supply that is coming onto the market. March PMI numbers are adding to this dismal view.

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Industrial output of China as related to the PMI. Credit: Reuters

As Reuters recently reported the Markit/HSBC Purchasing Managers’ Index (PMI) fell to an eight-month low of 48.0 in March. The index has been below the 50 level since January, indicating a contraction this year.

The HSBC measure is seen as the most reliable of the PMI estimates but even the National Bureau of Statistics (NBS) official state PMI only rose to 50.3 in March from 50.2 in February when March is traditionally a strong month after the New Year of January/February. HSBC’s measure is focused more on smaller to medium-sized private firms whereas the NBS PMI is focused on the larger state enterprises. Either way, manufacturing is struggling and, as such, growth will fall below the government’s 7.5% target this year based on current projections.

Premier Li Keqiang has already provided signs that he will not allow that to happen, as good as announcing stimulus spending is coming. Reuters reported a speech on March 28 in which he said the government “will launch relevant and forceful measures” to counter a cooling economy.

This is widely taken as infrastructure spending on railways and the like, ramping up demand for steel, copper and cement, and increased demand for those commodities in turn boosts consumption of energy and transport fuels.

Commodity prices are low compared to twelve months ago and supply is plentiful – at least for iron ore, coal, copper and oil – so while this is not likely to cause a rapid spike in prices, expect price levels to firm in the second half of the year as projects begin to get underway. No announcement has been made yet and even in China projects take some months to get underway so as the consequences of the 1st quarter’s performance sink in, it could be later in the month before Beijing makes any announcements. As with last year, infrastructure spending is supportive rather than bullish for prices. We are not talking a return to the super cycle but more likely an end to the fall in prices we have seen over the last six months.

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