Since the beginning of 2021, many countries have reopened their economies and introduced large stimulus packages amidst the (ongoing) Covid-19 pandemic. There was also strong demand for various industrial raw materials from large importers such as China. As a result, the prices of commodities such as iron, steel, copper, and crude oil had skyrocketed and hit record highs. marketfeed had prepared a detailed article in February on the various factors that led to the rally in commodity prices.
However, the monumental gains posted by certain commodities since January have been wiped out over the past week or so. Copper prices have corrected over 15% from their all-time highs. The prices of palladium, platinum, and even corn futures have also fallen sharply. Let us understand the primary reason behind the fall in commodity prices.
China’s Efforts to Slow Inflation
On June 16, the Chinese government asked state-owned companies to limit their exposure to foreign commodities markets. These firms will be forced to release strategic reserves of metals such as zinc, copper, and aluminium in batches to industrial consumers in order to stabilise prices. When China (the world’s top consumer of metals) cuts down on imports, it will surely lead to a decline in global prices. Soon after this announcement took place, the prices of metals fell heavily. We saw the Nifty Metal index fall by around 9% last week!
Now, why did China introduce such a measure?
China’s Producer Price Index (PPI) increased by 9% in May, the highest growth in nearly 13 years. However, the rising prices of various industrial raw materials (inputs) are making Chinese products less competitive. The companies that manufacture these industrial commodities are unable to pass on their high costs to consumers. This is because inflationary pressures pose a risk to overall economic growth in China.
The Chinese Communist Party’s Global Times (a state-owned publication) had reported that the country’s manufacturers were suffering because high input costs were deeply affecting their margins. For example, home appliances are usually sold at a discount around April, but companies were forced to raise prices. They can hike prices as their costs go up, but this practice/trend cannot last for a long period. Moreover, the end price is subject to certain contracts and other factors, which cannot be altered quickly. Thus, a strategic release of metal reserves will help China control prices and keep inflation in check.
Other Measures Taken by China
On May 24, 2021, Chinese regulators had warned metal manufacturers to maintain good market order. The regulators began to strengthen inspections of both futures and spot markets while cracking down on irregularities and malicious speculation. This had led to a sharp fall in metal prices. [Spot markets are where commodities are traded for immediate delivery. A commodity futures contract is an agreement to buy or sell a predetermined amount of a commodity at a specific price on a specific date in the future].
Why are Actions Taken by China so Important?
As most of you are aware, China is a major player in the global commodities markets. They import large quantities of iron ore, steel, and other metals for their development activities. The country is also notorious for hoarding steel and driving up its prices. Markets around the world keenly watch out for every statement or action made by Chinese authorities. When the country was industrialising rapidly at the turn of the century, its demand for raw material triggered a commodities supercycle. A supercycle is an extended period of high demand growth that producers (or suppliers) struggle to match. This ultimately leads to an increase in commodity prices.
Despite its high influence, experts say China may not be able to take on market forces (or cool down prices) in the long term. Investment banking firm Goldman Sachs believes that China ‘does not have the muscle to change the price trend’ of commodities. The firm further said prices were rising because of a global demand-supply mismatch. On June 22, ace investor Rakesh Jhunjhunwala said the steel supercycle had just begun and will last for 5-7 years. He is super bullish on the metals sector as a whole.
There is a complete lack of transparency over the quantity of reserves China holds, and how much would be sold over a certain period. Thus, experts and traders are unable to make an accurate forecast. Even though China does not have enough inventory to change the global outlook for commodities, it can certainly influence overall sentiment.
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