Is China Stocking Up On Commodities?

by: Andrew Hecht

Industrial commodities prices have rallied over recent weeks.

North Korea becomes a nuclear power.

The U.S., South Korea, and Japan counter North Korean moves.

War could close down shipping lanes in Asia.

Stocking up just in case.

In the world of commodities, China is the world’s most influential consumer. China’s population of almost 1.4 billion and its economic growth over past decades created massive requirements for raw materials. While the Asian nation is a leading producer of many commodities in its own right, China has been a significant customer of other raw material producers around the world to meet the country’s needs. China has not only been a buyer from other commodities producers around the globe but it has also made significant investments in commodities production across all continents.

China’s position as the leading consumer of natural resources in the world has put the nation in a dominant position when it comes to the path of least resistance for prices. When China is buying, prices tend to move higher, and when they are not, we have seen bear market conditions in many industrial commodities. In late 2015 and early 2016, when China’s economy cooled and its domestic equity market moved appreciably lower, the prices of many raw materials moved to multi year lows.

The Chinese government under the leadership of President Xi announced a policy of a “new normal” in 2016 where economic growth would be lower than the double-digit level seen over past years, but it would be stable. The new expectations for Chinese growth helped markets recover, and many commodities prices moved higher. While the path of least resistance for raw material prices is a multivariable equation, China is only one of those variables. However, over recent weeks, we have seen signs that China is buying many raw materials once again. Chinese stockpiling could be the result of events transpiring in Asia which could impact shipping and other commercial aspects of the raw materials markets.

Industrial commodities prices have rallied over recent weeks

No one should ever underestimate the influence of the Chinese on raw material markets. When China is buying, prices go higher, and when it is not, the path of least resistance tends to be lower. Over recent weeks, the prices of many staple commodities that are the critical building blocks of infrastructure have been moving to the upside. Source: CQG

The weekly chart of COMEX copper shows that the price broke out on a technical basis in July when it surpassed the $2.823 resistance level established in February 2017 and moved to its most recent high at $2.9265 per pound. Copper is a bellwether industrial commodity, and it continues to trade above the technical breakout level. Source: CQG

After trading down to the lowest level of 2017 at $42.05 per barrel in late June, the price of NYMEX crude oil futures rallied back to the $50 per barrel level which has been the pivot point for the energy commodity throughout this year. Crude oil is the energy commodity that powers the world. Source: Barchart

The price of September iron ore futures rallied from lows of $52.31 in mid-June of this year to $75.38, an increase of 44% in less than two months. Iron ore is the primary ingredient in steel which is a commodity that is a staple when it comes to construction projects. Source: CQG

Lumber futures have rebounded from lows of $340.30 per 1,000 board feet in late May and early June to over the $367 level. Lumber is also a critical raw material when it comes to building infrastructure and homes and a bellwether commodity when it comes to global economic conditions. While the prices of these four raw material markets have moved higher, other metals and minerals have also experienced a rebound in prices. Source: BDIY Quote - Baltic Dry Index

The Baltic Dry Index is a representation of shipping rates for dry bulk cargos, and it has risen from 820 on July 10 to over 1,030, which is an indication that demand for commodities is increasing. When it comes to the world of commodities, shipping often travels from production to consumption site, and China continues to be the largest and most influential consumer on the globe.

The recent rebound in raw materials prices could not have occurred without Chinese buying and perhaps stockpiling of many industrial commodities. The price rebound in the sector has been widespread among many different products, and the rally could be the result of a complicated political situation currently playing out in the Asian continent.

North Korea becomes a nuclear power

North Korea has been an isolated nation and one of the world’s poorest since the end of the Korean conflict in the 1950s. The Kim dynasty has ruled the nation with an iron fist for over a half century with its principal goal maintaining and increasing the military might of the country that borders China and is north of the DMZ that separates it from South Korea. In 2017, the young leader of the nation has succeeded in making North Korea a nuclear power. Over recent months, a series of missile tests have proven successful, and now, many military analysts believe that North Korea has the capability of inflicting catastrophic damage on its neighboring enemy nations of South Korea and Japan as well as both coasts of the United States. The most recent North Korean missile test on July 28 was the 14th of 2017. An ICBM fired from the Changang Province in the north of the country re-entered the atmosphere where people in Japan witnessed the event. The missile landed 230 miles off the coast of Japan, Los Angeles, Denver, Chicago, Boston, Washington DC, and New York all appear to be within the range of the rocket which could carry a nuclear warhead from the trajectory of the launch and reentry according to military experts. The U.S. President and many other nations around the world have stated that a nuclear-powered North Korea is unacceptable and have vowed to take action against the rogue nation.

The U.S., South Korea, and Japan counter North Korean moves

The United States, together with its allies in the region, South Korea and Japan, has increased the number of military exercises in the Asian continent in response to the provocative actions from North Korea. The installation of the THAAD missile defense system in Japan and North Korea has become a bone of contention with the Chinese who fear that increasing tension with North Korea could lead to destabilization in the region. Additionally, the U.S. President Trump has put growing pressure on the Chinese to talk the North Koreans off of a pursuit which is currently on a dangerous path with threats and rhetoric flowing between the Kim Jong Un government and the United States. The Chinese have been trying to calm the situation urging peaceful means and diplomatic solutions through talks and compromise. However, both the United States and North Korea continue to ramp up rhetoric and military exercises, and the potential for armed conflict in the region has not been this high since the Korean War in the 1950s. Meanwhile, any war would likely lead to millions of casualties and could quickly spread around the globe as the technological advances when it comes to weaponry have made the consequences of such a conflict unthinkable. When it comes to Chinese involvement in the current war of words, any military or a covert attempt by the U.S. to depose the North Korean government could lead to a flood of millions of refugees into China. Additionally, a U.S. victory and overthrow of the North Korean government would shift the balance of power in the region which is unacceptable to the Chinese.

War could close down shipping lanes in Asia

The rhetoric coming out of Pyongyang has been constant and brutal when it comes to the current war of words. Given that Seoul, Korea is situated very close to the DMZ, even a conventional conflict would claim too many lives to imagine on the first day of fighting. At the same time, a war in the region would likely close down shipping lanes and make the transport of essential commodities difficult if not impossible. Therefore, the events of recent months and the war of words between the U.S. and North Korea could be a reason why the Chinese are stocking up on commodities to build strategic inventories in case of the outbreak of war in the region.

Stocking up just in case

I believe that the recent rally in raw material prices is at least partially the result of the increase in tension in the Korean Peninsula. While the two Korea’s have been at war since the 1950s and the United States has been on the site from a military perspective, the threat of conventional war has turned into the potential for a nuclear holocaust.

The demand for raw material in the world’s most populous nation has been growing along with its economy. While double-digit growth rates are likely a thing of the past in China, even a 6 or 7% rate today comes on a much larger GDP than in previous years and decades. Therefore, the raw material consumption in China continues to grow, and the country depends on the rest of the world for the commodities that fuel growth. The prospects for logistical problems in the region and the possibility of trade wars or worse could mean that China is taking the opportunity to stock up, just in case over recent weeks and months. If that continues, prices could move a lot higher for many minerals, metals, energy products as well as other commodities.

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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.