CBA: Chinese commodity demand will be determined by its smallest cities

Photo by China Photos/Getty Images

Chinese new home prices continued to recover in April, rising by a further 1.2% taking the year-on-year increase at 6.2%.

Both figures were the highest seen since early 2014.

As the chart below, supplied by the Commonwealth Bank, shows, the monthly gain was yet again led by larger, tier one cities, such as Shenzhen, Shanghai and Beijing, although there was a noticeable pickup in prices in smaller Chinese cities, including those deemed tier three or lower, the smallest surveyed by China’s National Bureau of Statistics.

While the most noticeable thing about the chart is the steep pullback in price growth in larger cities, courtesy of tighter buying restrictions being implemented in Shanghai and Shenzhen, two major financial capitals, Vivek Dhar, mining and energy commodities analyst at CBA, believes the most important feature of the chart is the acceleration in prices in smaller cities when it comes to the outlook for commodity prices.

“Prices rose by 0.4% in tier 3 cities and below, the largest increase since January 2014,” wrote Dhar in a research note released on Thursday.

“While new home prices in China have generally improved in the last year, it is the price growth in tier 3 cities and below in the last three months that is most relevant for China’s commodity demand.”

Dhar points out that during China’s unprecedented stimulus spend in 2008-09, something that saw the government ramp up infrastructure investment in an attempt to counteract the effects of the global financial crisis, smaller Chinese cities accounted for 80-90% of total Chinese property construction during this period.

As construction activity in these cities soared, so too did commodity demand and prices.

Eventually it left one almighty property glut, something that even today is still expected to take years to clear, even with the recent uptick in buying activity.

And now, just like in 2008-09 but on a smaller scale, construction activity is lifting, helping to boost commodity prices.

Dhar questions whether the recent acceleration in price growth can be sustained, noting that it is fueling concern that the recovery in house prices and construction activity in these cities is being driven by speculation rather than fundamentals.

“Property inventories still remain quite elevated in lower tier cities,” notes Dhar.

“This will likely remain a problem for China’s property sector, not only weighing on commodity demand at some point, but boosting concerns that the recent price uptick is more speculative than fundamental.

With China’s stimulus measures likely to fade later this year, we think construction demand will weaken in 2H16.”

However, Dhar puts one caveat on this call, suggesting that further price growth in these cities could see commodity demand strengthen.

That’s the question everyone is asking themselves given recent strength in bulk commodity prices.

The fundamentals don’t appear to be supportive, but nor were they at the start of the year. And for the moment construction activity remains strong, underpinning commodity demand and prices.

Business Insider Emails & Alerts

Site highlights each day to your inbox.

Follow Business Insider Australia on Facebook, Twitter, LinkedIn, and Instagram.