During the first quarter of 2021 Chinese commodity import demand has been incredibly robust. Iron ore and coal imports increased by 7.9% and 9% respectively compared with Q1 2020. But that was small beer compared with what happened with agricultural imports. Soybean imports rose a respectable 19%, wheat imports doubled and shipments of corn into China surged 5-fold!
Naturally part of this is a base effect related to disruption early in 2020, part of it relates to lingering logistical delays problems (Chinese port delays) and some will be due to production problems (for example, rain in Brazil delayed the soybean harvest). The rebound in construction and manufacturing activity will also have supported import demand for commodities. According to the Caixin/Markit PMI survey, Chinese factory output in April grew at the strongest pace in four months.
However, there are already sings of problems emerging. The same PMI survey revealed that manufacturers input costs are increasing at their fastest pace since 2017. There are signs that the squeeze on margins means manufacturers are reluctant to take on new export orders. That could weigh on economic activity and commodity import demand going forward.
The Chinese leadership face a delicate balancing act over the rest of 2021 and into 2022. There are a number of interrelated factors to watch out for. Each factor has implications for commodity imports and hence the outlook for commodity prices.
1. Yuan supremacy – how to balance economic growth versus global ambition
In early Chinese Premier Li Keqiang announced that the country had a target of achieving GDP growth of at least 6% in 2021. Central to achieving that outcome will be the Chinese currency the yuan, also known as the renminbi. Since May 2020 the yuan has strengthened by 10% against the US dollar to 6.47 USD/CNY. Since most commodities are priced in dollars, a stronger yuan lowers the cost of imports for buyers in China, supporting commodity demand.
Authorities need to strike a balance between keeping Chinese goods competitive enough in global markets, while at the same time ensuring that input cost inflation doesn’t cut into economic growth. In a remarkable change from the policy of recent years, the Chinese may start to come under pressure to weaken their currency if inflationary pressures build elsewhere in the world. The last thing the Federal Reserve and other central banks want to do is to be forced to increase interest rates.
In August 2015 a surprise devaluation of the yuan shook markets. The 4% fall in the yuan was bad news for commodity prices which had already weakened considerably since 2011, since it made them more expensive to import. Chinese manufacturers and other importers will be wary of history repeating itself, and may have factored that into their buying activity, stockpiling commodities against the risk of a devaluation in the yuan later in 2021.
It may not be as straight forward this time however. The task is complicated by Chinese ambition for the yuan. China plans to roll out its digital yuan in early 2022, presenting it to the world at the Winter Olympics, to be held in the country’s capital, Beijing in February next year.
China’s central bank digital currency (CBDC) will be able to be used across borders, including trade flows, cross border payments and currency exchange. This is potentially a game-changer for portfolio flows into China making it much easier for foreign investors to buy Chinese bonds and equities. Nations on China’s Belt and Road Initiative may be required to use the digital yuan, bypassing the US dollar. All of which points to a stronger yuan, and a weaker US dollar. That’s good for commodity prices, but it’s also an inflationary tailwind.
2. The ravening hoards – is food insecurity worse than it appears?
According to S&P, Chinese demand for grains during the 2020/21 season (which started in October) is expected to increase by over 50% versus levels seen in 2018/19. The vast imports during the first quarter of 2021 are reported to be due to China rebuilding their grain reserves. The reserves are thought to have been depleted after the Asian Swine flu epidemic hit their hog herds; rebuilding will require a lot of feed.
China’s commodity data has always been murky, and that’s putting it politely. The concern from many is that China is in a much worse state than it’s letting on. Only a few years ago authorities were adamant that it’s “temporary reserve” of corn held a gargantuan 260 million tonnes. That was more than enough to fatten up some pigs. Where did all the corn go?
Last week China’s Food and Strategic Commodity Reserve Administration and several other departments released “Notice on Problems Related to Strengthening State Daily Management and Legal Supervision of Policy-Type Grain.” According to the Dim Sums blog the document suggests that “reports of empty warehouses, granaries that burst into flames, and inedible reserves are more widespread than the government has admitted”.
If China faces a much more acute shortage of corn and other grains than it’s letting on then expect imports to remain strong through the rest of the year. That points to authorities keeping the yuan strong in order to reduce its import bill.
3. Keeping up appearances – balancing pollution against the risk of blackouts
The Chinese authorities face another delicate balancing act as winter approaches. On the one hand they cannot risk a repeat of the power shortages that afflicted many cities last winter. Freezing temperatures and a shortage of coal meant that tens of millions of Chinese citizens shivered as provincial governments curbed power consumption.
China has of course attempted to pivot towards renewable energy. Issues as innocuous as a sand covering solar panels and grinding the gears of wind turbines after a sandstorm has led to drop in confidence that renewable energy can guarantee that the lights stay on and ensure homes are kept warm next winter.
Meanwhile, all eyes will be on China in February 2022 as the Winter Olympics begins. With minimal annual snowfall in the mountains surrounding Beijing, the authorities will have to use around 50 million gallons of water to produce fake snow. They will also need to ensure that the skies are blue too. This will mean forcing heavy industry to cut back output in the months ahead of the event.
The last time China staged the Olympics is a useful precedent. A construction boom ahead of the 2008 Olympics was one factor behind the final surge in the commodity super-cycle. As the event approached and activity wound down authorities imposed restrictions on all manner of industrial activities to in order to cut pollution.
Related article: The start of a dry bulk super-cycle?