China

So the much anticipated China rate cut didn’t quite eventuate.

The deflationary print of late last week had led much of the market to expect movement in the benchmark policy lending rate.

Now, commodities, and some equity markets, ran hard on the idea of additional China stimulus, to reboot property, to expand overall demand, and to offset these deflationary impulses.

But no big stimulus has been unleased. By comparison, you can see in the below graph the money supply movements over the GFC, in 2015, in 2020, but not a lot in the post COVID 2022-2023 period.

Those were big, visible from space (or at least, easily visible in the graph, with c30-40% moves in M1 (narrow measure) and M2 (broader measure)). TSF stands for total all-system financing aggregate, so you’ve got detail on both money and credit supply movements in the above graph.

Now, splitting up that TSF metric into its components, you can see the big spike in renminbi bank loans back during the GFC era (08-10), that was noticable, and certainly relative to the size of the economy at the time.

And whilst in a general sense, money and credit aggregate growth at ~9% (the current number) might seem high, it is also the case that it is getting less and less traction with GDP growth.

You can see the idea of “less and less traction” in the below graph, which shows the debt-to-GDP ratio continues to climb. How long can it climb? Well, seeming longer than you might think.

Both household and corporate debt levels continue to climb, as does government (not shown).

However, I doubt that any kind of major fiscal crisis is coming for China. Their foreign exchange reserves are too large, they run large surpluses, they control the flow of capital, and can quite easily step in and instruct banks on how to handle (prevent) bank runs or credit crunches internally.

So what conclusions can we make?

Well, we probably don’t need to short China’s equity market. It is very cheap, cheap for a reason, sure, but small exposures are probably fine, as long as the region doesn’t erupt into a military conflict in/over/with Taiwan and Taiwan’s allies. That’s a non-zero risk, but at the moment, that risk also extends to European equities, where Russian success or otherwise depends very much on how much support Ukraine gets from its near neighbours.

And we can probably recognise from the above graphs that previous bouts of stimulus don’t seem to have worked, since debt/GDP metrics keep rising, while economic aggregates keep slowing. So if more stimulus isn’t working (and indeed might be the problem!) it seems reasonable to conclude that maybe the reason we’ve not seen a big stimulus program, over the last 6 months despite everyone thinking one was coming (including and up to this “lack of rate cut” the market anticipated) is due to recognition that a new economic model is needed, one that isn’t dependant on rate cuts to steady the ship.

And indeed, China can in fact righten the economic ship, by accepting lower growth, moving away from stimulus (of manufacturing, of fixed asset investment, of property sectors) and instead prioritising healthcare, education, social services, aged care, unemployment benefits, basically uplifting the expenditure on all of those things by a lot.

The takeaway for us is that commodities, which have run hard on China stimulus stories, aren’t likely to see much action on this front. Now China’s imports for iron ore and coking coal and copper and LNG have been quite strong, and so maybe that is an arguement for commodity price strength, but if we are right that the model is-and-will-change, and that some degree of speculation is priced into commodities like iron ore, then the future portends much weaker demand, and therefore weaker prices, for commodities.

Some of the below commodities seem to reflect this narrative I’ve just outlined. Caustic soda, alumina, aluminium, China hot rolled steel, even copper, all look fairly weak. Thermal coal, oil, these are certainly not strong. Nickel is so weak we’ve seen plenty of local Aussie companies go bust, or put mines on care and maintenance (the whole battery complex, including lithium, has felt this).

But the view has not held at all for iron ore. Met coal seems to be sitting in the middle.

I’d thought that coking coal railed in from Mongolia would weigh on the seaborne market, thus far that hasn’t happened either.

The CISA steel production data does provide some support that perhaps iron ore and met coal are simply due to join the peers across the other key base, bulk and industrial metals.

Time will tell.

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