Chinese demand for industrial metals fell to its weakest level since the global financial crisis in the first quarter of 2015, and while easier financial conditions suggests demand will likely pick up modestly in the months ahead, the improvement is unlikely to last.
That’s the bearish picture painted by Max Layton, Yubin Fu and Jeffrey Currey of Goldman Sachs’ commodity research team who, in a note released over the weekend, said that “risks surrounding our medium-term metals demand growth and price forecasts remain skewed to the downside”.
They point to Goldman’s China metals consumption index (MCI) which, as the chart below shows, fell to its lowest level since the height of the GFC in July in annualised terms.
The MCI is based on an equally weighted basket of ‘physical output’ data for the main commodity consuming components of China’s industrial production, according to Goldman.
It measures consumption of metals in Chinese industrial production in volume terms. It does not include Chinese commodity production, something Goldman point out may “explain the divergence between extremely bearish metals prices and commodity-producer currency action, and the solid headline Chinese GDP (+7%) and IP (+6%/7%) data for 1H15”.
While the MCI picked up slightly month-on-month in July, pointing to a “very slight growth in metals and mining consumption on a sequential basis”, the trio note that the rebound was off a very low base.
Despite the slight uptick in consumption recorded, it was not enough to offset a continued expansion in industrial metals supply, leading to industrial metals prices falling further over the month.
Here’s the trio on why a widening supply surplus in industrial metals contributed to lower commodity prices.
“During July and early August, metals prices fell sharply, perhaps more sharply than would be expected given the slight positive GS China MCI growth in June and July. The metals price weakness and corresponding commodity-producer currency weakness in our view reflects the fact that the very slight pickup in demand that began in 2Q15 has not been enough to balance markets, in part reflecting the fact that metals supply has generally continued to grow”.
The chart below illustrates the widening gap which exists between industrial metal supply and Chinese demand.
While the trio forecast that Chinese demand will improve slightly in the months ahead, it’s unlikely to be enough to bring the market back into equilibrium in the absence of major output cuts.
Looking ahead, Goldman believes any uptick in demand is likely to be short lived.
“With China’s credit growth still running at roughly double the rate of GDP growth, China is likely to continue to slow credit growth over the medium to long term. As such, any major credit-led pick-up in Chinese metals demand growth is likely to be short lived, in our view. This prospect suggests the risks surrounding our medium-term metals demand growth and price forecasts remain skewed to the downside”.
The trio remain “very bearish” towards copper, something which may explain the spot price hitting a fresh multi-year low overnight, although they believe the nickel price at its current levels “represent a buying/consumer hedging opportunity”.