Copper at risk, gold to benefit from a Chinese hard landing – Barclays
According to a new note, Barclays says the likelihood that China might experience an economic hard landing has increased, which would have a significant effect on commodities markets.
Posted: Monday , 08 Jul 2013
JOHANNESBURG (Mineweb) -
Like the white noise from household electronics that is only noticeable in its absence during a power failure, so the global commodities sector has got used to double digit growth from China.
While there is no doubt that Chinese growth has slowed, initial panicked reaction from markets about this slowdown was replaced by the recognition that, while it is slowing, 7 – 8% is still very respectable.
According to a new note by Barclays, however, recent tightening in liquidity conditions, weaker business confidence and slowing growth have increased the likelihood of a hard landing, albeit a short-lived one, for the Chinese economy.
In its latest Commodities Weekly note, the bank writes, “Although not their base case our China economists now believe that a period in which quarterly growth drops briefly to 3% at some point in the next three years is an increasingly likely scenario.”
The bank’s baseline view is for the Chinese economy to grow 7.4% in 2013 and 2014. But Barclays says that, since taking office in mid-March, the Li Keqiang-led government has taken a different economic policy path from its predecessor focusing on three key pillars – no stimulus, deleveraging and structural reform.
This policy, which its economists have dubbed ‘Likonomics’, and is focused among other things on bringing China into a more market-oriented economy, will be good over the long term. But, Barclays says, it also could lead to “further downside risks for both economic growth and asset prices, including the exchange rate”.
To look at the impacts of such a hard landing, the bank modeled the impact of a 4% annual fall in Chinese aluminium and copper demand.
Such a scenario would mark the first annual fall in China’s metals demand since 1988 and would lead to a jump in the global refined copper market surplus to 1m tonnes from the current base case estimate of a 100,000 tonne surplus.
“For aluminium,” it says, “the model projects that the surplus would widen to 3.5m tonnes (a big increase from the base-case surplus of just under 1m tonnes), taking the stocks-to-consumption ratio to the highest since the mid-1990s when the market was in such overcapacity that a memorandum of understanding was signed by producers to agree to cut back production.”
The bank is quick to note that, while during the 2008 financial crisis, it was the country’s aluminium and nickel consumption that was hit hardest (down 11% and 18% respectively over quarter-on-quarter) as a result of significant stock overhangs and supply-chain destocking, this time around, stocks are significantly leaner.
Barclays says, unlike in 2008, aluminium, nickel and zinc have already been in bear markets for some time, with balances in surplus, high stocks and prices already trading into cost curves. As a result, the downside is more limited than in 2008.
Copper on the other hand, is particularly vulnerable to a hard landing now because it has the furthest to fall, the bank says, adding, “It is also the metal most leveraged to China due to the country’s large import requirement.”
Accordingly, Barclays writes: “Copper prices could fall to $2553/t (over 60% from current prices), lead prices could fall to $850/t and zinc to just over a $1000/t (for both metals a 40-50% fall from current levels). In contrast, the potential downside for aluminium is a lot less, with a decline of 30% from current levels to a potential $1234/t.”
The news for metals isn’t all bad however. According to Barclays, gold could benefit were a hard landing to happen.
If it is not already, China is likely to become the world’s number one consumer of gold this year, unseating its rival India. But, according to Barclays, “A steep fall in China’s growth could be the trigger for an acceleration in structural changes in the country’s gold demand. A hard landing could shake faith in the government and lead to a big fall in CNY-denominated assets which could mean gold becomes important for domestic investors to hedge what we think they will view as a greater set of risks than previously.”
It adds, “It could be the trigger in moving China away from being a country that increases purchases at festivals or when inflation is high or when there’s a big fall in international prices, to one where gold is added more consistently to portfolios.”