Our call is that the Chinese economy will slow in the back half of 2017. Beijing is pumping the brakes on last year's significant monetary and fiscal stimulus. This slowdown would help perpetuate another leg down in commodity-oriented reflation over the intermediate term.
Specifically, far and away the most important development in China's recent GDP release is the fact that the nominal growth rate of China’s manufacturing sector ("Old China") decelerated from a cycle-peak of +14.2% year-over-year in the first quarter of 2017 to +12.7% year-over-year in the second quarter of 2017. While that may not seem like much of a pullback, it does mark the first sequential deceleration since nominal growth in this sector bottomed at +0.9% YoY in the third quarter of 2015.
The 2016 “recovery” in the Chinese economy was predicated on the growth rate of heavy industry and this was perpetuated by a significant amount of fiscal and monetary stimulus, as Hedgeye Senior Macro analyst Darius Dale wrote recently. Already in 2017, the People’s Bank of China has pulled back significantly.
PBoC Open Market Operations are down -246% year-over-year in 2017 versus an increase of +689% year-over-year by this time last year. For the full year of 2016, the PBoC pumped a staggering net 1.727 trillion Chinese yuan into mainland financial markets. So expect the Chinese manufacturing sector to continue to fade alongside Beijing stimulus.
Why does China's Slowing Economy matter?
- China represents roughly half of global demand for major base metals, according to the IMF.
- China has also become the largest importer of metals, with its share increasing from less than 10% to 46% from 2002 to 2014.
- The country actually consumes about half the world’s production of refined copper, iron ore, aluminum and smelted and refined nickel.
Now consider this study from Gauvin and Rebillard (2015)...
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"China’s rapid growth over the past decade has been one of the main drivers of the rise in energy and mineral commodity demand and prices: over the last ten years, 133 percent of the increase in global copper consumption has been driven by China, 108 percent for nickel, 85 percent for iron ore, 85 percent for coal, and 42 percent for oil." –Gauvin and Rebillard 2015 |
BOTTOM LINE
We reiterate our bearish bias on the “Old China” economy with respect to the intermediate term and suspect that the nascent deceleration highlighted by the Q2 GDP data will morph into a full-blown negative trend over the next few months. If we're right, commodities will take a hit.
