Friday 22 May 2015
Positioning for Chinese stimulus
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:
- Interest rate cuts
- Pro-growth policy reform including relaxation of home ownership requirements and loan deposit ratios, and;
- 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
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.
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