Commodity Chill
John Stephenson's E-Letter
April 22, 2013
It was a rough week for stocks and commodities as the S&P
500 ushered in its biggest retreat since November 2012, while commodities
slumped 7 percent as China reported a weaker-than-expected growth rate of 7.7
percent. Gold futures tumbled to $1,395.60 an ounce and copper retreated 5.6
percent, to end the week in bear market territory with the largest decline since
December 2011.
The news of China’s surprisingly slow growth rate put a chill
over global commodity producers, which had previously enjoyed years of
relentlessly strong demand and prices as the building boom in the world’s second
largest economy went on unabated. But with China’s growth cooling, so too will
its appetite for coal, iron ore, copper, nickel and many other commodities,
calling into question the notion of a continuing commodity supercycle.
More worrisome than the short-term quarterly noise for commodity
investors is the longer term shifts in China’s economy as it transitions away
from its role as a manufacturing juggernaut. This past weekend, People’s Bank of
China Governor Zhou Xiaochuan was quoted as saying “We need to sacrifice
short-term growth for the purposes of reforms and structural adjustments” and
that the 7.7 percent first quarter GDP growth posted by China was “normal.”
China’s leadership is actively trying to stimulate domestic consumption at the
expense of export-led manufacturing growth. As well, the Chinese economy is
transitioning toward an increased service orientation, further cutting demand
for natural resources as labor and capital shift from manufacturing to services.
This year will mark the first time that services will surpass industrial output
in China.
At the heart of the transformation is China’s new leadership,
led by President Xi Jinping and his early determination to restructure the
economy. Also telling, was the fact that most of the posturing surrounding the
release of this key economic data point was focused on concern over the rising
property market, rather than on the relative weakness of the quarterly growth
numbers. But the pace of economic growth in the first quarter marked the first
time in two decades where four consecutive quarters of sub-eight percent
expansion was recorded.
Environmental concerns, declines in the working-age population
and income gains that are pushing up costs also suggest that Chinese growth may
need to slow to a new normal of closer to 7.5 percent, rather than the
greater-than 10 percent growth rates of the recent past. Adding to the concern
over slowing Chinese growth is sharply dropping exports to the U.S. and Europe .
Iron ore stocks are a third greater than average, piled up in three-storey
mounds at the Qingdao port, while copper stocks at Shanghai’s bonded warehouses
are double the usual average.
But so far, Chinese officials seem determined to stay the course
on badly needed reforms for the economy. This spring a 20 percent “windfall tax”
on property sales was introduced in an attempt to cool the overheated property
market that is rife with speculators, and the government has promised further
reforms to state-owned enterprises and the banking sector which is teetering
under a mountain of bad debt.
Further impacting Chinese growth is a sluggish Europe, which is
a much more important export market for Chinese firms than America . While the
Cyprus issue appears to be on the back-burner for now and no new political
flare-ups are in the offering, the Eurozone is likely to be stuck in the slow
lane for the foreseeable future. Uncompetitive economies such as Greece and
Italy are still shackled to the euro, which is too lofty to help them enjoy the
boost from exports which comes from a devalued currency.
I have been reducing my exposure to the resources sector for
some time now, and believe that the best vantage point is from the sidelines.
Gold will likely slump in the years ahead, falling to $1,100 per ounce in 2014
and beyond, while base metal demand will continue to falter as China transitions
to a service-led economy. Energy is the only bright light in the resource sector
however energy tends to be a late-cycle performer when global economic growth is
on an upswing.
The U.S. economy and stock market will rebound in the months
ahead, driven by the renewed vigour of the U.S. consumer. Initial economic
indicators are showing that the U.S. economy accelerated at 3.1 percent in the
first quarter, led by the biggest gain in consumer spending in the past two
years. I'm looking forward to a great 2013, but my gains won't be coming from
the commodity sector rather they will be coming from U.S. stocks that are poised
for even loftier heights, driven by a resurgent America.
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