Chinese economic policy uncertainty set to rise

Every five years members of the Chinese Communist Party meet for its Party Congress. The event is typically where the ruling party shuffles leadership and addresses economic reform. Previous meetings have coincided with important announcements on investment in infrastructure. Currently scheduled for this October, the 19th such meeting may also be an important marker board for commodity markets.

Over the past couple years officials have embarked on a series of measures to try and cut production capacity across a range of industries including steel, coal and more recently aluminium. Cuts to domestic capacity have caused seaborne prices for these commodities and others related to them to soar as supply struggles to meet China’s infrastructure investment. One of the aims of these capacity slashing measures has been to improve environmental conditions, particularly those located in urban areas on the east coast that have had to contend with thick smog on a regular basis. However, more pertinent are Chinese authorities attention on financial stability and deleveraging as a critical objective.

Any backtrack on this focus may be a signal that markets may have got too far ahead of themselves. Look for any change in China’s commitment to a GDP target. There is a wide expectation that the Party will reiterate its commitment of doubling GDP by 2020 from the 2010 level, which requires the economy to grow at an average rate of 6.5 per cent in 2016-2020. Also important will be the level of support President Xi’s agenda. If his power is seen as weakened it may be interpreted as a negative for commodity markets and a sign increased volatility.

Previous Party Congress meetings have got some form in dashing expectations for higher prices. The chart below looks back at how copper prices performed before and after the past 5 Party Congress meetings. Copper prices typically rise in the twelve months preceding the meeting, and then peak 1-2 months before declining over the next twelve months to end below price levels seen 24 months earlier.

For sure, previous meetings have coincided with some tumultuous economic events. In 1997, just a few months before the Party Congress, the Asian Financial Crisis was just getting started with Thailand abandoning its currency peg against the US dollar. A series of currency devaluations by other countries in the region caused stock market declines and sharp drops in economic activity. And then in 2007 the Global Financial Crisis got underway as troubles emerged at Bear Sterns and interbank lending markets froze. The knock-on impact on confidence caused copper prices to fall initially and although they later rebounded, further bad news on the scale of the crisis caused copper prices to drop several months after the CCP. Nevertheless, both 1992 and 2012 exhibit the same trend even though China’s importance to overall copper demand radically changed during the intervening 20 years.

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Pigs might fly: Why China’s plan to reduce meat consumption is more than just about the environment

Last month the Chinese Nutrition Society called on consumers to reduce the amount of animal-based food they eat from about 300 grams to 200 grams a day and their meat consumption from about 62 kg to 27 kg per year.

The Beijing-backed health agency hopes the guidelines will help ward off a growing obesity and a diabetes time-bomb in China, while global warming campaigners believe they could also result in huge benefits for the planet.

But there is also a macroeconomic benefit too.

Pork prices are a serious matter in China, and is a significant driver of consumer inflation. Chinese consumer inflation is closely watched by authorities eager to maintain social stability and food security. For example, the “blue-ear pig” disease that forced Chinese farmers to slaughter millions of pigs in 2008 drove the country’s inflation rate to its highest level in a decade.

To prevent further disruptions, the Chinese government established a strategic pork reserve, keeping icy warehouses around the country stocked with frozen pork for release during times of shortage. The government was forced to add to the reserve in the spring of 2010 when a glut led to prices collapsing.

Since the start of 2016 pork prices have surged 70% in China after the nations herd was cut following clampdowns on waste and pollution, coupled with rising demand. In response to the sharp rise in prices Beijing’s municipal government unveiled an unprecedented release of 3.05m kg of frozen pork reserve into the capital’s market over two months.

Reducing Chinese consumers consumption of meat could reduce its impact on overall consumer inflation, enabling Chinese policymakers to manage its economy more effectively. The impact would be far wider however reducing Chinese demand for animal feed including soymeal and corn.

Ultimately it is going to be very difficult to change Chinese consumers taste for meat. As with other economies as they reach a certain stage of development consumers demand a greater proportion of protein based food such as meat, eggs and dairy products. That is unlikely to change anytime soon.

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End to seasonal stock build likely to signal end to iron ore price rally

Prices for the steel-making raw material declined to a near decade low in mid-January, but have since surged by 37% to $47.73 per tonne, its highest level since June. Prices have surged amid restocking by Chinese steel mills and signs of decreased iron ore supply.

Chart: Apr-16 iron ore futures contract


Set in a longer term context, this move is a drop in the ocean. Just two years ago iron ore prices were over $120 per tonne.

In China, which accounts for about 50 per cent of global steel supply, benchmark steel prices have also climbed, bolstering mills’ margins. Rebar, used in construction, closed at 1962 yuan ($US301) a tonne earlier this week after closing at a record low of 1626 yuan in November.

Will the rebound continue? It appears unlikely if seasonal trends in China’s steel industry remain.

Construction activity typically picks up in China shortly after the Lunar New Year break and so the most active period for steel production in China occurs in May-Aug each year. Production rates tend to decline from Sept- Nov, reducing the need for iron ore and coking coal before restocking begins ahead of the next rise in production.

Port stockpiles of iron ore in China climbed to 95.55 million tons on Friday, the highest level since May 2015, to head for a sixth monthly increase, according to weekly data compiled by Shanghai Steelhome Information Technology Co.

steel, coal and iron ore price trends

Related article: Seasonal price trends in steel and base metals

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