CBA: Chinese property inventories could determine commodity prices in 2017

Photo by China Photos/Getty Images

The year is almost done and, as yet, there’s no sign of weakness in commodity prices, which has surprised more than a few.

What started out as a short-term boost from increased infrastructure investment in China — initiated by policymakers earlier this year to address a noticeable slowdown in economic activity — has extended for far longer than many expected, providing a welcome boost to miners, and the government coffers of major commodity producers, after years of relentless price declines.

While some of that resilience can be explained by hopes for increased infrastructure investment in the US under a Trump presidency, as the major end-user for most commodities worldwide, much of the strength is continuing to be driven by China.

One look at recent manufacturing and services PMI data from the world’s second-largest economy — both hitting multi-year highs in November — goes a long way to explaining the ongoing strength in prices.

The question everyone in now asking is what will happen next?

Will China take the foot off the fiscal accelerator in 2017, leading to renewed price weakness, or will it continue with the status quo?

And will Trump’s mooted fiscally-funded infrastructure plans also come to fruition, or will they be scuppered by fiscal conservatives?

No one really knows the answer, particularly after what they’ve seen in 2016.

But some have an idea as to what will dictate the direction for commodity prices.

Vivek Dhar, a mining and energy analyst at the Commonwealth Bank, says Chinese housing inventory levels will go a long way to determining what will happen next.

In a note released on Tuesday, Dhar says falling housing inventory levels — something that began in mid-2015 — are a sign of healthy demand for commodities, helping to explain why prices have remained supported in 2016.

“The fate of China’s property sector has been closely intertwined with commodity prices in the last decade, with a stronger Chinese property market usually correlating with stronger commodity prices,” he says.

“2016 has proven no different, as surging property sales and prices have compelled policy makers to step in and curb further increases in property prices – particularly in tier 1 and 2 cities.”

To explain why inventory levels have been falling, Dhar says that property sales rose by 27% in the first 10 months of the year compared to the same period in 2015, significantly faster than 3% increase in construction activity over the same period.

While he believes that sales growth will likely slow in 2017, with inventory levels continuing to move lower in both large, medium and smaller cities, Dhar says that the trajectory of housing construction remains less clear.

“Even if sales falls next year, the flow through effect to construction may be less severe,” says Dhar.

“This risk is further accentuated when we take into account the drawdown in China’s property inventories, particularly in in tier 3 and 4 cities where the bulk of construction activity takes place.”

Should inventory levels continue to decline, Dhar says construction may be supported next year even if sales fall.

Although he is forecasting renewed commodity price weakness, he says stronger construction activity in China is a major upside risk to the bank’s commodity price forecasts in 2017.

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