Why a China slowdown is bad news for commodities and the global economy

China’s rapid growth and spending on infrastructure has powered demand for global commodities for a number of years
But, with ongoing Covid-19 lockdowns and a construction slowdown, commodity producers around the world will need to consider new resilience strategies

Boris Ivanov

Published: 12:15pm, 2 Aug 2022

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China is the biggest commodity consumer in the world by virtue of its population and economic growth. Its economic health has a great bearing on the course of commodity prices – particularly metals and minerals. For a few years, China’s infrastructure spending has been driving growing demand for commodities including steel, copper and aluminium.

However, that is about to change as Chinese growth slows. The implications for regional trading partners and the world remain to be seen.

China’s fast-growing economy was sufficient to push imports higher each year. However, this year, the International Monetary Fund expects the Chinese economy to expand by just 3.3 per cent, which is well below the government’s official target of “around 5.5 per cent”.

Beijing recognises that change is afoot. At the quarterly economic meeting on July 28, the Politburo said growth should be kept within “a reasonable range”.

The conflict in Ukraine, resurgent inflation and a slowdown in China’s construction sector have all contributed to a volatile first half of 2022 for commodity prices. China continues to struggle with mounting Covid-19 cases and full or partial lockdowns in large cities, including the financial and manufacturing hub of Shanghai. This continues to delay economic recovery.

In China’s once-booming property market, home sales have fallen year-on-year for 11 consecutive months. Several Chinese developers have stopped constructing the homes that were already sold because of cash flow concerns. In recent weeks, some homebuyers have threatened to stop paying their mortgages until the work resumes. The property market is in a precarious position.

Despite government stimulus and a policy shift to a more supportive, pro-growth setting, the Chinese model is facing challenges after years of rapid growth. This could spell trouble for the rest of the world, which relies on China’s economic engine to power demand for their energy, food and materials.

Take crude oil for example: China’s imports are heavily driven by travel and transport. Due to China’s zero-Covid policy, the lockdowns and shutdowns mean that many refiners will cut back on purchases. With stockpiles remaining high, elevated international prices will put off prospective buyers – slowing the recovery of China’s crude imports.

Similarly, with gas and coal, there are signs of an unprecedented decline in imports, including perhaps a 15 per cent drop in demand for liquefied natural gas. However, amid shifting trends towards clean coal and growth in the use of renewable energy, a decline should not be a major surprise.

A reduction in coal imports is driven by the virtual halt on purchases of Australian coal since late 2020 amid escalating tensions between Beijing and Canberra, which sent imports from the once major coal supplier to zero.

As a result, China ramped up domestic mining to record levels and introduced price caps that made imports unprofitable. In fact, according to the China Coal Transportation and Distribution Association, imports of coal will drop by 22 per cent, to 250 million tons this year.

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Following Beijing’s orders to reduce output from steel mills and therefore carbon emissions, China’s iron ore imports are also slowing compared to last year. With another cut in steel output due this year, iron ore imports are expected to drop.

The move to produce cleaner steel from scrap has had an impact on Chinese steelmakers. Also, nearly 90 per cent have suffered losses from weak sales and low prices, according to Chinese industry data provider Mysteel.

Considering the situation in the property sector, the iron ore market can expect more trouble. Iron ore is perhaps tied to early-cycle property activity in China more than any other global commodity as the sector produces nearly a third of China’s steel and iron ore demand.

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While there are plans for China to launch a property fund to help developers, the policy support is likely to focus on completions of pre-bought units. There are concerns that this will benefit later-cycle raw materials such as copper and aluminium, instead of iron ore.

Despite falling demand for many commodities, copper and copper ore have emerged as bright spots. Shipments of both continue to run ahead of last year and, late last month, copper prices climbed to their strongest in two weeks, amid optimism around new infrastructure projects in China.

Some of the biggest mining companies in the world, including Rio Tinto and BHP, recently signalled there is more economic pain to come, amid geopolitical tensions, inflation and policy tightening.

For commodity producers, a lack of demand will cause raw material prices to fall, hitting commodity-dependent economies hard as it makes the extraction and export of such materials unviable. Some producers may even face a life-and-death crisis as they try to cut costs wherever possible to battle falling revenue amid reduced demand.

Even the major producers are in trouble. Rising costs, royalty demands and deflated iron ore and copper prices will pile pressure on earnings growth forecasts at BHP and Rio Tinto after two years of record numbers and payouts for investors.

Free cash flow is likely to be squeezed next year due to a combination of higher costs and lower commodity prices. In these circumstances, smaller commodity producers could show improved performance if they are agile and able to de-risk portfolios.

Governments and big companies around the world will need to consider new strategies to ensure greater resilience, security and sustainability now that China’s imports of key commodities face powerful headwinds. The global economy is deflating and the clock is ticking. China’s role in shaping the world’s economic recovery just got bigger.

Boris Ivanov is the founder of Emiral Resources Ltd, a global mining group that focuses on exploration, mining and production of the Earth’s mineral resources