Chinese Economic Activity Raises Concerns for Commodities Demand

Another round of lackluster readings on Chinese economic activity on Tuesday has raised concerns over the demand for metals and other commodities, according to an economist. Kieran Tompkins, a commodities economist at Capital Economics, highlighted the need for China’s policymakers to deliver on promises of stimulus in order to sustain the recent rally in industrial metals prices.

The China Caixin manufacturing purchasing managers index (PMI) dropped to 49.2 in July from 50.5 in June, indicating contraction in the sector for the first time in three months. In contrast, China’s official manufacturing PMI rose slightly to 49.3 in July, up from 49.0 in June. These readings suggest a broad slowdown in factory activity and a contracting manufacturing sector.

The slow recovery of China’s economy following the pandemic has been cited as a factor contributing to the weakness in commodity prices, especially oil, during the first half of 2023. While the Chinese government has pledged to support economic activity, they have yet to unveil significant stimulus measures. Despite this, the market has responded positively, with Chinese stocks experiencing a rally in July. Both Brent and West Texas Intermediate have also reached three-month highs.

These latest PMI readings serve as a warning sign for commodities demand, affirming the need for China’s policymakers to fulfill their promises of stimulus to sustain the recent rally in industrial metals prices.

Front-month Copper Futures Jump in July

Front-month copper futures (HGU23, -2.03%) experienced a significant increase of 6.8% in July, reaching the highest level since April 20. This surge in industrial metals was largely attributed to the release of a comprehensive policy document by China’s top economic planning agency. The document aimed to remove consumption restrictions and enhance infrastructure development, among other measures. Daria Efanova, head of research at Sucden Financial, highlighted these events and their impact on the market.

Impacts of China’s Stimulus on Consumption

While the stimulus implemented by China is primarily focused on consumers, Efanova believes that its ability to stimulate consumption in the near term may be limited. The prevailing weak consumer confidence continues to play a crucial role in the slow demand. Although supply conditions are expected to improve, this alone is unlikely to lead to sustainable increases in base metals prices. Efanova emphasized this viewpoint in her note.

Metals Prices Retreat as Equities Decline

On Tuesday, metals prices experienced a decline while Chinese and European equities faced concerns regarding their activity levels. The performance of U.S. stocks offered a mixed picture, with the Dow Jones Industrial Average (DJIA, -0.03%) increasing marginally by 0.1%, while the S&P 500 (SPX, -0.34%) decreased by 0.3%.

Impact of Caixin Manufacturing PMI on Export Activity

Analyzing Tuesday’s data, Tompkins noted that the new export orders balance in the Caixin manufacturing PMI dropped from 50.1, entering contraction territory at 46.1 in July. Historically, there has been a relationship between prices and export activity, suggesting that this reduction in export orders may have negatively influenced industrial metals prices. The chart below illustrates this relationship.

Concerns about a Slowdown in Exports

Despite the resilience of exports to key markets like the U.S., Tompkins predicts a “marked slowdown” later in the year. This prediction is supported by declines in PMI readings for services and construction, signaling a broader deterioration of China’s economy. Tompkins expresses concern about the health of commodities demand, but remains optimistic that Chinese fiscal stimulus measures will stabilize activity in the construction sector.

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