Positioning for Chinese stimulus

Market insights

Friday 22 May 2015

China has started cutting rates. So what does this mean for Australia and our key exports?

Ask any Australian and they will tell you that China saved Australia from the worst ravages of the global financial crisis. The flip side is that the current Chinese structural slowdown is impacting the Australian economy. As a result of this slowdown, in the past six months China has begun stimulating the economy.

In this article we investigate the potential for further Chinese stimulus and the impacts on Australia and in particular our key resource exports, such as iron ore.

China is slowing down

On the surface China's March quarter headline GDP number of 7% growth released last month was in line with the government's full year target. However, delving deeper into the data it is apparent that the world's second largest economy slowed markedly during the period from September 2014 to March 2015. As highlighted by the orange line in the chart below, quarter on quarter GDP growth was just 5.2%. Clearly an increase in growth over the remainder of the year is needed in order to avoid a so-called "hard landing".

Source: CEIC, Macquarie, May 2015

Chinese Government response

Like much of the developed world, China is cutting rates and stimulating the economy. Co-ordinated fiscal policy and monetary easing has continued with Sunday 10th May marking the third cut in benchmark interest rates since November 2014. This follows other monetary easing policies that released 1.5 Trillion Chinese Renimbi (USD 194bn) into the banking system. In order of likelihood, we anticipate further Chinese stimulus may take place in three key areas:

  1. Interest rate cuts
  2. Pro-growth policy reform including relaxation of home ownership requirements and loan deposit ratios, and;
  3. Direct investment in infrastructure projects including rail, public transport, and utilities.

Impact on Aussie commodities – identifying the opportunities

The impact of a slowing Chinese economy and correspondingly weak demand was a defining feature of Australian equity markets in late 2014 and early 2015. This was evident in the poor price performance of most major commodities with the Australian trade-weighted basket of commodities falling by ~20% over the period and the S&P ASX 200 materials index declining 8% (cushioned by a falling exchange rate).

The sheer scale of the investment by the big mining companies over the past decade has now caused an environment of rising supply at a time of slowing demand, particularly in iron ore and coal (commonly known as bulk commodities).

In contrast, markets where demand is broadly equivalent to supply stand to benefit the most from an increase in Chinese demand. In these markets, a small increase in demand from China is likely to lead to raw material shortages and prices will increase. In this respect we see copper, nickel and zinc as the most attractive opportunities within our investment universe as highlighted below.

Source: WorldSteel, Wood Mackenzie, Company data, Macquarie, May 2015

Summary

The China economy is undeniably undergoing a structural slow down which appeared to accelerate in Q1 2015. In reaction to this, China policy makers have begun a concerted process of easing including three interest rate cuts since November 2014. We expect these actions to stabilise demand, but expect different commodities will react differently. Bulk commodities such as iron ore are facing a serious oversupply and we expect changes in demand to have little impact to prices. On the other hand, base metals such as Copper and Nickel with more balanced supply / demand outlooks could see prices rise in reaction to higher demand.

This article is part of our From the desk series, featuring monthly insights from the Macquarie High Conviction Fund and the Macquarie Australian Small Companies Fund team members.

 

Related solutions

Managed funds

Share this

Related articles


 

Find out how we can help


If you'd like to speak to a specialist about how we can help build your business, get in touch.

This information has been prepared by Macquarie Investment Management Limited ABN 66 002 867 003, AFSL 237492 ("MIML"), the issuer of units in the Funds mentioned above and is current as at August 2015.The information in this email is provided for general information purposes only and does not take into account the investment objectives, financial situation or needs of any person. It should not be relied upon in determining whether to invest in a fund. In deciding whether to acquire or continue to hold an investment in a Fund, investors should consider the product disclosure statement. The product disclosure statement is available from MIML by phoning 1800 814 523.

Future results are impossible to predict. This report includes opinions, estimates and other forward-looking statements, which are, by their very nature, subject to various risks and uncertainties. Actual events or results may differ materially, positively or negatively, from those reflected or contemplated in such forward-looking statements. Forward-looking statements constitute our judgement as at the date of preparation of this report and are subject to change without notice.

Investments in a Fund are not deposits with or other liabilities of Macquarie Bank Limited or of any other Macquarie Group entity and are subject to investment risk, including possible delays in repayment and loss of income and capital invested. None of Macquarie Bank Limited or any other member of the Macquarie Group guarantees any particular rate of return or the performance of a Fund, nor do they guarantee the repayment of capital from a Fund.

Except for Macquarie Bank Limited ABN 46 008 583 542 AFSL and Australian Credit Licence 237502 (MBL), any Macquarie entity referred to on this page is not an authorised deposit-taking institution for the purposes of the Banking Act 1959 (Cth). That entity's obligations do not represent deposits or other liabilities of MBL. MBL does not guarantee or otherwise provide assurance in respect of the obligations of that entity, unless noted otherwise.

Important Information

Restricted to financial services professionals

This information on this website is provided for the use of financial services professionals only. In no circumstances is it to be used by a potential investor for the purposes of making a decision about a financial product or class of products.

In order to proceed, please confirm that you are a financial services professional by clicking 'I accept'.