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Chinese Demand Will Continue to Drive Commodity Prices – Especially Copper

Winston Churchill famously described Russia as “a riddle wrapped in a mystery inside an enigma” the key to which was its “national interest.” He might well have said the same thing about China, an emerging superpower which is now challenging the United States dominance not only on the economic front but militarily as well.

To say that China will be a major influence on the global economy in the future is probably a gross understatement, especially for those working in the commodities sector given its insatiable demand for commodities including industrial minerals and petroleum products.

President Trump has good reason to fear Chinese influence – both military and economic – and the United States’ massive $700 billion plus defence budget underscores the importance it places on the former. China has been building manmade bases over some of the Spratly Islands in the South China Sea since 2014, much to the annoyance of other powers in the region including the Philippines, Malaysia, Vietnam, and Japan. All lay claim to parts of the sea which is a valuable trade passage and fishing ground.

Just recently the aircraft carrier USS Carl Vinson visited Vietnam, anchoring two nautical miles off the port city of Danang which was a key battleground during a long, costly war that ended when the U.S. evacuated its last remaining military forces from the country in 1975. The ancient proverb, “the enemy of my enemy is my friend” no doubt sums up the situation between the two best. In the end, politics makes strange bedfellows and often two historically opposing parties can work together against a common enemy which in this case is obviously China.

Trump has opened hostilities by imposing tariffs on China, claiming the country has been dumping steel, aluminum and other products in the U.S. market, costing American jobs. In the case of aluminum foil, the U.S. Commerce Department concluded that Chinese exporters were selling it at 49% to 106% below fair value in addition to receiving unfair subsidies of 17% to 81% of the goods’ value.

The U.S. administration has justified the implementation of the tariffs citing “national security” concerns, much to the chagrin of Canada, a major supplier of these commodities and a strategic ally – both militarily and economically. Canada and Mexico have since been exempted from the tariffs but the administration has linked this exemption to a successful (from the U.S. perspective) conclusion to the NAFTA negotiations which for the moment at least appear to be deadlocked.

China’s supply side discipline can make-or-break industrial metal sentiment and this factor will drive commodity markets in the coming years, according to The Economist Intelligence Unit. The ratcheting up of political tensions between the two countries could positively impact precious metals and oil, with the impact on industrial minerals perhaps being less quantifiable.

Given its system of government, China has much more flexibility in terms of resolving its economic challenges compared to the West. Among its principal economic problems are industrial overcapacity (the reason for dumping excess production into foreign economies), a frothy property market (Hong Kong is the world’s least affordable commercial centre), and dangerously high levels of corporate debt.

China has numerous state-owned companies but cuts in industrial capacity to date have mostly involved private firms which tend to be more vulnerable to government-led closures because of a lack of legal protection and weaker political connections. The environmental cost of pollution linked to heavy industry has also given rise to social unrest and China has forced the closure of many of these high pollution commercial enterprises.

By the end of 2015 the coal and steel industries accounted for around 14% of corporate debt within China’s industrial sector. Furthermore, exports of products from overcapacity sectors were generating tensions in China’s international trade relations, especially with the U.S. which recently imposed tariffs. The U.S. is said to account for 14% of China’s total aluminum exports and about 2.9% of steel imports, according to Reuters News Agency, while Canada supplies an aggregate one-quarter of them.

With China’s cost advantages slipping, the government is looking to upgrade industrial production capabilities to better align them with domestic demand. A report by UK-based  BMI Research noted that “Chinese fiscal support to the construction sector has buoyed domestic industrial metal demand, especially through public-private partnerships in public infrastructure such as airports, water, rail, power and roads and bridges (that will) continue at least until the end of 2017.”

Anglo-Australian multinational, BHP, sees China’s economic growth rate moderating “longer term” as the working age population falls, impacting demand for consumer goods. In the near term, BHP believes “China’s economic structure is expected to continue to rebalance from industry to services and growth drivers are likely to shift from investment and exports towards consumption” which will continue to be “vital for the copper market.”

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