Over the past two years, the Russo-Ukrainian war has disrupted grain supplies from the Black Sea region and rerouted global energy shipments as Europe largely stopped buying Russian oil and natural gas.  In addition, OPEC+ has cut oil production by 3.6 million barrels per day, and more recently, the Israel-Hamas conflict has heightened uncertainty in oil markets while Houthi attacks on vessels have diverted some shipping traffic from the Red Sea.  Despite these developments and the rise in geopolitical tension, prices for key commodities such as crude oil, corn, wheat and soybeans are at or lower than levels before Russia invaded Ukraine in 2022 (Figures 1, 2 and 3). 

Figure 1: Corn and oil prices are down over 35% since June 2022 despite rising geopolitical tensions

Figure 2: Wheat prices are 50% off their highs since 2022.

Figure 3: Soybean prices are also down more than 30% from their highs.

While there are multiple reasons for this, including surging U.S. crude oil production (Figure 4), one reason appears to dominate: slow growth in China.  There is also stiff competition among producers. OPEC+ and U.S. frackers are competing for the title of swing producer – those who are able to increase output swiftly and without any significant impact on costs.  Farmers in the U.S., Brazil and the Black Sea are vying for the mantle of swing producers in crops such as corn, soybeans and wheat.  China, on the other hand, is the undisputed swing consumer of all of these products, and the recent weakness in the world’s second largest economy explains why prices for a range of commodities including aluminum and copper have generally fallen in the past two years despite a favorable supply environment.  

Figure 4: U.S. crude production has surged, replacing roughly half of what OPEC+ cut.

Nearly all commodity prices track economic developments in China, usually with a lag of about one year.  Chinese growth reached peaks in 2007, 2010, 2017 and 2021.  In each case, prices for key commodities peaked one year later in 2008, 2011, 2018 and 2022.  This is also the case during slowdowns in Chinese growth.  This phenomenon can be tracked using a proxy for Chinese growth such as the Li Keqiang Index, which measures rail freight volumes, electricity production and the number of bank loans. (We show the correlation between WTI and the Li Keqiang Index along with prices for various other commodities 12 months later in charts 5 to 7. Charts for other commodities can be found in the appendix).  

Figure 5: WTI Crude prices follow Chinese growth with a lag typically around one

Figure 6: The correlation between Chinese growth and WTI prices peaks after 4-5 quarters delay

Figure 7: China’s growth rate correlates with price levels of many commodities one year later

China’s economy has struggled amid soaring debt levels and an overreliance on the residential real estate sector.  During the 2008 global financial crisis, China’s total public and private sector debt was much lower than that of Europe and the U.S. as a percentage of GDP. Since then, Chinese debt levels have surpassed those of Europe and the U.S. (Figure 8).  Meanwhile, China’s real estate sector ballooned from 8% of GDP in the late 1990s to nearly 30% by the mid-2010s (Figure 9).  

Figure 8: China’s debt levels have surpassed those of the U.S. and UK

Figure 9: China’s reliance on the real estate sector has ballooned

This has been especially problematic as the Chinese real estate sector has begun to contract, with home prices falling and construction activity declining sharply (Figures 10 and 11).  There has also been a sharp slowdown in the growth of China’s industrial output and consumer spending (Figures 12 and 13). Moreover, China’s exports volumes have fallen by 13% over the past two years, while import volumes have fallen by nearly 17% (Figure 14).  

Figure 10: China’s real estate sector has begun to contract

Figure 11: China’s construction activity has declined sharply

Figure 12: China’s growth in industrial production has fallen sharply

Figure 13: Consumer spending in China has been falling

Figure 14: China’s exports and imports have been declining

Adding to China’s challenges are low inflation, high real interest rates, falling equity prices and a potentially overvalued currency.  While falling prices are a great thing for consumers, it makes life difficult for debtors who must pay back loans with money that is worth more than it was when they borrowed. This tends to increase default rates.  Indeed, 34 of China’s 50 largest property developers are in some form of default on loan obligations, which has led to a sharp fall in the value of Chinese high-yields bonds (Figure 15).  Falling bond prices means higher yields which, in turn, means higher financing costs of corporate debt. 

Figure 15: The value of Chinese high yield bonds has been falling

In this environment, one might have expected China’s yuan (CNY) to fall in value versus the U.S. dollar (USD), which it has done but only to a very limited extent (Figure 16).  Moreover, while nearly every central bank on the planet has been raising rates, China’s central bank has been easing policy by lowering its reserve requirement ratio and cutting interest rates.  Even so, the Peoples Bank of China’s (PBOC) policy rate remains well above the country’s core inflation rate (Figure 17

Figure 16: China has been loosening monetary policy while most other nations have raised

Figure 17: China has low inflation, central bank has been cutting rates

When crises such as the global financial meltdown and COVID-19 struck the U.S. and Europe, their central banks lowered policy rates to near zero and held them below inflation for years, successfully reviving economic growth.  The PBOC may be reluctant to do so because lowering rates significantly could further increase pressure for capital flight as yuan holders might seek higher returns elsewhere.  While a weaker currency and lower rates might make sense economically, such an outcome may be antithetical to promoting the Chinese currency as a global reserve asset in the near term.  Additionally, a weaker currency could provoke a protectionist response from the U.S. or Europe, should they deem it to constitute an unfair trade practice.

Additionally, there has been little progress in China towards structural reforms that might boost growth.  In Europe and the U.S., consumer spending accounts for 60-70% of GDP.  In China, that number is typically closer to 35%.  One solution would be policies that would boost consumer spending, such as a developing a social safety net (unemployment insurance, retirement benefits and subsidizing health care costs) that would allow Chinese households to reduce their saving rates from 30% to perhaps 5% or 10%, more in line with the global average.

One of the key reasons why Chinese growth has been relatively weak is that the Chinese government has provided relatively little in the way of fiscal support, unlike the U.S. which sent its economy into overdrive via COVID-related fiscal stimulus.  When the pandemic struck, Western governments concluded that, given their populations’ low saving rates, massive fiscal stimulus was necessary.  This sent global consumer spending and the resultant Chinese output and exports soaring in 2020 and 2021, which in turn boosted commodity prices through mid-2022.  By contrast, the Chinese government did relatively little stimulus, leaving Chinese households to dig into their personal savings in order to survive the pandemic.  As COVID restrictions were lifted in late 2022, China’s economy did boom, albeit briefly, as many expected in large part because Chinese consumers remain focused on rebuilding housing balance sheets amid depleted savings, falling home prices and falling values for equity and fixed income investments. 

Perhaps most worrying is the possible impact of soaring central bank rates elsewhere, including the Fed’s 525 basis points of rate hikes, which could slow the global economy and hence further reduce demand for Chinese exports.  Chinese exports are already under downward pressure from the shift in consumer spending back towards services and experiences from manufactured goods as well as from the trend towards onshoring and nearshoring production to reduce dependency on Chinese manufacturers.

It's not yet clear if China’s economic fortunes will revive in 2024 or not.  Whatever happens, the direction of Chinas’ economy appears likely to remain the primary influence on commodity prices in the years to come and, if the past is any guide, traders may be able to get a head start on upcoming moves in commodity prices by keeping a close eye on China’s economic data. 

Appendix Charts

Appendix 1: Corn prices tend to peak/bottom around 4-6 quarters after Chinese growth

Appendix 2: Corn prices correlate with Chinese growth with a delay of 4-6 quarters

Appendix 3: Soybean oil prices tend to follow Chinese growth with a 4 quarter lag

Appendix 4: Soybean oil prices tend to follow Chinese growth with a 4 quarter lag

Appendix 5: Wheat prices tend to follow Chinese growth with a 4-5 quarter

Appendix 6: Wheat prices tend to follow Chinese growth with a 4-5 quarter

Appendix 7: Copper prices follow Chinese growth of a lag of up to one year

Appendix 8: Copper prices follow Chinese growth of a lag of up to one year

Appendix 9: Aluminum prices follow Chinese growth of a lag of up to one year

Appendix 10: Aluminum prices follow Chinese growth of a lag of up to one year

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