Commodities: A China Story?

Over the last several decades commodity prices have been closely tied to China and its increasing demand for natural resources.  Recently there has been a slowdown in China's population growth and a decline in their GDP while commodities have continued to do well.  What else could be influencing commodity prices?






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Transcript

Commodities: A China Story?
Season 2: Episode 3

Ryan: Welcome to the Real Spiel with Ryan and Kurt. Let's talk about the China story and commodities. We've seen diversified commodities up 25% year to date and have been strong since their April 2020 pandemic lows. Other financial assets did recover from their pandemic lows but have since corrected. The big story of commodity prices has been the China story over the past couple of decades. You know the commodity correlations to China's GDP, but it's not the entire picture. And what I want to talk about is the rest of the story of commodities and what has happened in the commodity markets over the past couple of years and not to downplay China, they are the second largest economy in the world. 19% of the world's population, roughly fifteen percent of global GDP. And they're also humongous consumers of commodities, over half of the consumption of coal, copper steel, nickel and nearly half of the pork and aluminum consumption. With that their population growth has slowed. Their GDP has leveled off.  And in the face of those factors, commodities have done well, so it's becoming more and more clear that commodity prices are not just about China. What else do we need to keep an eye on Kurt?

 Kurt: Yeah, Hey Ryan. I couldn't agree more. I mean, I think China’s importance to support for commodity prices over the prior two decades is kind of hard to overstate. I mean, they were expanding their economy from what we used to be classified as an emerging market into what is now the world's second largest economy. And they did this by huge construction efforts with roads, railways, building cities of millions of people from scratch. And that was creating a huge demand for concrete, for copper for aluminum for steel and energy as well. But I think that because commodities are something that's relatively new in the investment world. Commodities probably didn't really appear in portfolios until maybe fifteen to twenty years ago. I think that China story has synched very, very closely with investors experience.  How is it possible that commodities can continue to grow and expand without that engine of growth that China supported? But the reality is, I guess a couple things one as you pointed out, China has slowed in the last say, eighteen months and yet we've seen diversified commodities go up roughly 100% in the last, say, two and a half years. 

 And in this year in Twenty-two, we've seen stocks and bonds both decline while diversified commodities are up as you had said, roughly 25%. That sort of dichotomy and returns is extraordinary. And it can't be a China story, if that's only what’s supporting this return generation has to be something else going on. The other thing I would point to is just something that we've talked about before that commodities have been around for centuries. As futures they've been around for roughly one hundred fifty years. So going all the way back to the 1870s in the US, if you look at commodity returns, diversified commodity returns from exchange traded futures markets. They did very well from the 1870s, 1880s, all the way up to the 1960s. How is that possible that you could have a century of returns from commodities that are comparable to equities or other financial assets when China was not any part of the story for those multiple decades? I think there's investing themes that are present whether in equities it might be industrial growth, might be biotech and might be Internet technology stocks. There are different themes that can drive returns in sector outperformance. Healthcare, for example, I think within commodities, there are different things that drive the expansion, whether it's a wartime effort or an OPEC embargo other events that can lead to new demand. Right now, what we're dealing with is a transformation towards renewable energy and electric vehicles. Demand in China for those raw materials to support that growth is going to be very strong. China is maybe more aggressively than any other country, developed country moving towards a fully renewable transportation fleet. They have a commitment to do that inside hundred percent in less than ten years. So that's gonna be demand for aluminum demand for to some extent, steel a large demand for copper and another kind of industrial metals that might not trade in futures markets, but lithium, cobalt, nickel is an example of a key metal that's used in battery technology, all of that demand is gonna be strong even with less traditional industrial growth that we saw from China and the prior twenty years. And I think there's other economies, countries in Africa. It could be India that are going to they still have a lot of growth potential and you're gonna see expansion of their local economies demand for these raw materials that will continue to grow. 

 Ryan: Yeah. Absolutely. And another point about commodity prices as well would be the U.S. dollar strength. U.S. dollar versus commodity prices. Of course, an inverse relationship dollar priced exports of American produced commodities are less competitive on the world stage, and prices must come down or fall to match the effective price of global competitors. The U.S. Dollar index is up over fifteen percent year to date, while commodities are also up twenty five percent year to date. You see that as a tailwind for commodities going forward?

 Kurt: I think I do. And I think the traditional wisdom is that because commodities are all typically priced on a global stage in dollars. If the dollar gets stronger than you would anticipate that the price of commodities would all things being equal go down and converse vice versa. That said, I think that the source of dollar strength makes sense. We have a slowly weaker global economy. More concerns about stability of income, stability of assets dollar has always been a reserve currency. Treasuries and US markets have always been places of refuge for investors, and we're hiking rates. So, the Fed itself is creating a stronger dollar by paying more and more and causing banks to pay more and more for dollar reserves. I think we're playing a little bit of catch up here. We've talked about this before that the Fed maybe has even longer to go. Markets can anticipate that. And that could be a tailwind for dollar strength. That said, just like the China story can't be the entire story to commodities, the dollar story is either. And while we've seen China GDP weaken and we've seen the dollar strengthen; we've seen continued robust returns coming from diversified commodities. So, there's something else underlying that's happening in markets. I think it has to do with the basic supply/demand role that companies play. We're seeing continued demand for raw materials and energy. Record prices in certain areas of the world, like in Europe, as they are dealing with constrained supplies coming out of Russia and traditional sources that they've used for decades, and there's a whole transition undergoing the economy in Europe about how they're going to power their factories, their homes over the next winter. And over the next decade, I think we're seeing global robust demand for certain industrial metals to support this renewable energy electric vehicle transformation, even legislative support. For example, the inflation reduction act has been signed into law. I think since the last time that we talked earlier before the summer, that's hundreds of billions of dollars that's going to be spent as committed dollars I can tell you this if the government, if Congress passes a law and the President signs it that we're going to spend this money, they will spend it, they will find a way. So that's going to create, you know, organic robust demand for these raw materials. And I think it goes to some length beyond the traditional kind of common China story that we've gotten used to over the last 10-20 years. And I think it also means you can have a strong dollar while you're seeing robust returns generated from money markets. 

 Ryan: Absolutely. And this has been the Real Spiel with Ryan and Kurt. We would love to hear your questions, feedback, hear about topics of interest. Please reach out to us at therealspiel@USCFinvestments.Com and like and subscribe. We will talk to you next week.