The Real Concern For Commodities: China

by: Market Blog

By David Berman

Commodities have been on a wild ride over the past several weeks, as investors fret over the European debt crisis and the rising possibility of another U.S. recession. But Murray Leith, director of research at Odlum Brown, argues that the real concern affecting commodities actually comes from China

“When it comes to China, the trends are worrisome,” he said in a note to clients. “Shares of China’s private property developers have been hit hard. The Shanghai Stock Exchange Property Index has dropped to a two-year low and is down more than 50 per cent from its high in the summer of 2009. Chinese bank stocks have also performed very poorly. The Hang Seng Composite Financial Index is down roughly 40 per cent from its 52-week high.

“China consumes more energy than the United States, and 40 per cent of the world’s copper. The fact that oil and copper prices are down about 30 per cent from their respective summer highs may be an indication that commodity demand from China is waning.”

At the heart of the problem are tighter fiscal and monetary policies, where Chinese authorities have attempted to contain rising inflation that arose from stimulus policies during the last financial crisis and global recession. These new policies are slowing down the Chinese economy in general and having a particular impact on real estate. Indeed, Mr. Leith notes that there is already anecdotal evidence that the economic boom may be faltering.

“Investors are so pessimistic about the outlook for China’s property developers that analysts at JPMorgan estimate that property development share prices are discounting a 20 per cent decline in housing prices across the nation,” he said.

So, is it all bad news ahead? Not exactly. Mr. Leith is not predicting a so-called hard landing for China and believes that authorities there will take action against deteriorating economic conditions.

“Regardless of whether they are successful or not, we would expect such policy action to have a positive influence on investor sentiment and security prices in the short term,” he said. “More specifically, if China lowers interest rates and bank reserve requirements, we would anticipate a very positive reaction from resource stocks and other securities geared to China’s economy.”