Commodities Monthly: Downside Risks As Perfect Storm Is Gathering‏

While energy and grains prices have in fact held up fairly well during the latest market turmoil, accelerating fears over the Chinese way ahead have weighed on base metals, not least copper. As discussed in last week’s Commodities Update, fears over a weakening Chinese recovery are the key worry for commodities at present. Most commodity sectors did not join the rally seen in, e.g. equities following the third round of quantitative easing (QE) from the Fed in H2 last year and may thus be a little less vulnerable to the Fed announcing it will start to scale back on its asset purchases (i.e. tapering) later this year.

We have generally revised our price forecasts slightly lower for oil and metals and now see Brent crude oil averaging USD104/bbl (previously USD106) this year down to USD96 in 2014 (USD99). With China looking more fragile than has been the case for a long time we have also had to lower our forecasts for copper somewhat: we now see the red metal dropping below the USD7,000/MT level more consistently next year to average close to USD6,750.

Chinese economic policies turn less commodities bullish
Thus, Chinese developments are the key thing to watch for a guide to the demand side in commodities in the near future. The stress seen in China’s money market recently may partly be seasonally driven, but our economists emphasise that the signals from the Chinese authorities illustrate that the tolerance for weaker growth is now notably higher than was the case just a few years back. Crucially, focus has turned to minimising the risk of fuelling bubbles and implementing structural reforms rather than boosting the cyclical stance of the economy. Longer term, this is a welcome development as it could make Chinese economic growth more robust to external factors if China moves towards more consumption (rather than investment) driven activity.

Our economists have revised lower their forecast for Chinese GDP growth to ease below 7.5% y/y in the second half of 2013. This the Chinese leadership can probably live with but if growth slows below 7.0% y/y, the Chinese government will be forced to return focus to stabilising the economy. We stress that risks to our outlook for China remain on the downside. A key indicator to watch going forward is credit growth: if the People’s Bank of China (PBoC) allows interbank rates to stay elevated coupled with regulatory tightening, this could act as de-facto monetary tightening at a time when the economy looks increasingly fragile. In contrast, any signs of house price increases would be much welcome at present as inflation is not a worry for the PBoC at the moment.

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