Back pedal 12 months and the commodities landscape looked rather different.
Prices had been falling since 2011 and the trend carried through into early 2016. Many worried that the declines were set to continue through this year. 10 months in, the picture looks brighter: Chinese demand for metals has picked up and cost-cutting by producers has boosted profitability.
Commodities Are Up… But Why?
The S&P GSCI Commodities Index has risen from a low of 271.8 in late January to 372.4 today, a rise of 37%, aided by a doubling in oil prices during the period. Mining stocks are among the better-performing asset classes of 2016 and were doing well even before Brexit boosted the fortunes of London-listed stocks. There is a sense of cautious optimism about a recovery in commodities much of which has to do with improved sentiment toward China.
But, as we wrote recently, China’s strong demand for raw materials and increased output of steel, copper, aluminum and other metals has, in large part, been fueled by a robust housing market which, in turn, has benefited from Beijing’s stimulus measures.
Housing has been and remains a major driver of economic growth in China, but we have seen these debt-fueled stimulus programs before. They provide a period of growth between 12 and 24 months, depending on the sums pumped into the economy, and then their effects fade and the demand unwinds.
This raises the question whether the rebound in Chinese demand for raw materials used in construction — such as steel, copper and aluminum — can last. Given that China consumes more copper and aluminum than all other countries combined, the prices of these commodities will take a hit when China’s current sugar rush ends.
Where’s All of the Aluminum?
We are not about to call and end now, it will likely be well into next year before support falters, but in the medium term there is little to support continued upward price movements if Chinese demand slows. Nor are all commodities equal. Andy Home, writing this week for Reuters, focused on the aluminum market where the Shanghai Futures Exchange price has outperformed the London Metal Exchange by 30% to 13% as hot money has flowed into aluminum futures in China.
This might have been partly encouraged by a dramatic fall in SHFE ingot stocks from 212,000 metric tons to 85,000 mt this year. Trading volumes on the exchange have quadrupled on the year to date. This view of falling ingot stocks may be misplaced. As we wrote recently (and Reuters notes) some 70% of primary aluminum is now being consumed as liquid metal, which obviously cannot be delivered to the SHFE, so the exchange stocks of ingot are becoming drawn down not due to scarcity of primary metal but due to scarcity of just one, less popular, form of primary metal.
There is no shortage of aluminum in China, though, as rising semi-finished product exports show. Even with a rising SHFE domestic metal price, exports are flowing out the country.