Expect China’s Huge Commodity Demand To Continue In 2017
China saw its producer price index (PPI) in December rise 5.5 percent, its fastest pace in more than five years and fourth consecutive positive reading after 54 straight negative ones.
The country’s PPI, which measures prices received by producers at the first commercial sale, is strengthening on higher commodity prices. What’s more, there’s an 85 percent correlation between China’s PPI and its nominal GDP, according to Evercore ISI, so growth in the world’s second-largest economy should pick up some steam this year.
“Based on history, the PPI’s increase of +3.3. percent year-over-year (y/y) in the fourth quarter suggests +15 percent y/y nominal GDP growth,” the firm wrote. It estimates fourth-quarter growth to be more than 8.8 percent and more than 9.6 percent in the first quarter of this year.
Meanwhile, the country’s purchasing manager’s index (PMI) has remained at or above 50—indicating manufacturing expansion—for the past six months, which is bullish for commodity prices.
Chinese demand for commodities, which were up 25 percent in 2016, is indeed skyrocketing, with imports of oil, iron ore, copper and soybeans reaching all-time highs last year. This helped solidify the country’s role as the world’s top engine of economic growth once again, contributing an estimated 33.2 percent to global economic expansion, according to China’s National Bureau of Statistics.
It’s expected we’ll see a repeat of outsize commodity demand this year, which should support prices.
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Looking at copper, further support should come in the form of market deficits, which are expected to widen until at least 2020. As investment bank Jefferies explained in a note, “unexpected disruptions”—including undercapitalization of mines and the risk of labor strikes at Chile’s Escondida, the world’s largest copper mine—will likely add to supply constraints.
“From a supply perspective, the outlook for mined commodities is very bullish,” Jefferies added.
That includes gold. As a friend recently reminded me, China’s official gold holdings account for only 2 percent of its foreign reserves. Two percent! That’s remarkably low, far lower than most large economies. (In the U.S., it’s around 75 percent, according to the World Gold Council.) China is obviously interested in supporting its currency, and since it sold off quite a lot of U.S. Treasuries in the past year—Japan is now the top holder of U.S. government debt—it will likely need to substantially build up its gold reserves.
The People’s Bank of China (PBoC) has been accumulating gold, even if the rate has slowed recently, but imagine if it decided to boost holdings up from 2 percent of foreign reserves to 10 percent, which is more in line with other countries. That would have a monumental impact on the price of the yellow metal.
At this point, there’s no evidence the PBoC plans to follow such a route, but the possibility is there, with huge implications for gold.
The PowerShares DB Commodity Index Tracking Fund ETF (NYSE:DBC) was unchanged in premarket trading Wednesday. Year-to-date, the largest diversified commodity ETF has gained 0.25%, versus a 1.22% rise in the benchmark S&P 500 index during the same period.
DBC currently has an ETF Daily News SMART Grade of A (Strong Buy), and is ranked #2 of 122 ETFs in the Commodity ETFs category.
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The Small Business Optimism Index is compiled from a survey that is conducted each month by the National Federation of Independent Business (NFIB) of its members.
The Producer Price Index (PPI) measures prices received by producers at the first commercial sale. The index measures goods at three stages of production: finished, intermediate and crude. The Purchasing Manager’s Index is an indicator of the economic health of the manufacturing sector. The PMI index is based on five major indicators: new orders, inventory levels, production, supplier deliveries and the employment environment.
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