China's lopsided economic recovery and its impact on commodities

 Iron ore prices have plummeted to $104 a tonne from their peak of $130 a tonne in March. This fall has brought iron ore prices to the level last seen in November 2022. The market did not anticipate this drop in iron ore prices, especially after the Chinese economy opened up completely, ending COVID-19 lockdowns and restrictions on mobility earlier this year. But the issue is not just about iron ore or steel; China's economy is growing in a lopsided manner. Its manufacturing sector is under pressure despite receiving a boost from the economy's reopening, with the April manufacturing PMI slipping to 49.2 compared to March's 51.9, indicating a contraction in activity.

In contrast, the services PMI reading was still healthy at 56.4 but lower than the March figure of 57.8. Some experts speculate that China's economy is experiencing two types of recovery, one being a struggling manufacturing industry and the other being a robust domestic economy driven by consumer spending. This difference in growth may be attributed to the challenges faced by sectors such as real estate, where construction activity has slowed down due to the difficulties faced by major developers.

While the government and monetary authorities have been cautious with their stimulus efforts to avoid triggering inflationary fires that may be challenging to extinguish later, the situation spells bad news for commodities. Weak domestic demand for steel is likely to increase exports and lead to weak steel prices in most markets. This, coupled with falling iron ore and coking coal prices, could have a significant impact on commodities. Even non-ferrous metals like copper, zinc, and aluminum are experiencing a decline from their January levels.

The overhang of a slowing world economy may be a significant contributor to the sudden drop in crude oil prices. It was expected that China would contribute significantly to incremental oil consumption following its reopening in 2023. Additionally, chemicals are experiencing a decline in prices, with Tata Chemicals' share price affected by the fall in soda ash prices.

The situation does not bode well for India's companies involved in making commodities and intermediate goods. Falling prices are expected to reduce sales growth and margins, depending on the cost structure. However, the silver lining is that India's consumption economy may benefit significantly from this trend. Consumer goods ranging from FMCG to household appliances and cars may all become less expensive to produce, resulting in lower costs for consumers.

Despite this benefit, the question of weak demand remains, particularly in the rural economy, which continues to affect consumption. The outcome is favorable for the government's capital investment plans, but it may take longer for the private capex cycle to revive. The lower prices and margins may act as a disincentive for companies to invest.

Overall, the impact of China's lopsided economy and falling commodity prices could have far-reaching consequences, but it may also bring some benefits for India's consumption economy.

Highlights:

• ·   Iron ore prices have fallen to $104/tonne from their recent high of $130/tonne in March, reaching a level last seen in November 2022.
• ·   China's economy is growing lopsidedly, with the manufacturing sector under pressure and April's manufacturing PMI slipping to 49.2 from 51.9 in March, signifying a contraction in activity.
• ·   Consumer spending is recovering nicely in China, with the recent Labor Day weekend seeing travel exceeding its pre-pandemic level.
• ·   The weak manufacturing sector could be due to troubles in sectors such as real estate, where troubles of major developers have seen construction activity slow down.
• ·      Falling commodity prices, including iron ore and steel, could lead to weak steel prices in most markets and squeeze sales growth and margins for Indian companies that make these commodities and intermediate goods.
• ·    India's consumption economy could benefit significantly from falling commodity prices, with a whole range of consumer goods becoming less expensive to produce.
• ·    The private capex cycle may take longer to revive as lower prices and lower margins may act as a disincentive for companies to invest.
• ·    The government's capital investment plans will benefit from lower commodity prices.

Thank you for reading.