Ship Shape:
Crouching Tiger, Lockdown Dragon
There are big questions out there. Big questions about our future. Why we are here? What is the meaning of life? (the answer is 42 by the way), and big questions about the future of markets. One of the largest question marks looming over many markets is the role China is going to play, or indeed what impact China will have in the future.
The persistence of the zero-Covid policy of the People’s Republic of China, which was initially hailed as a harsh but effective policy, has now tied the hands of the Chinese Government, and is an especially spiky thorn in the side of President Xi. The close association with the premier has meant repealing the policy has been an absolute no go, as that would affirm that he can be wrong.
I can publicly announce that I have been wrong in the past, and in all likeliness be wrong many times in the future, but the inability to change this policy and progress to a stage of immunity seen in other countries, as coronavirus infects millions of people, building up immunity, means that they are stuck in a catch-22 situation.
This presents a problem for commodity markets and the wider world economy. As such a large consumer of raw materials, as well as being a key producer of many of the things we spend silly money on at Christmas time, lower economic activity in China could be a warning for markets and we have already seen the impact of the covid lockdowns in data coming out of China.
China’s April steel PMI was down to 40.5, from 44.3 in March and the overall figure is expected to be at 48.0 for April. Chinese refinery throughput seemed to be on the decline, as the country’s top refiner Sinopec stated that it had lowered operational rates to about 85% of capacity since the second half of March, compared to 92.6% earlier in the year, due to higher inventories from lockdown restrictions.
More recently, the stricter lockdowns have significantly dented domestic consumer activity with retail sales down 11.1% year on year, compared with forecasts of a 6.6 per cent fall by economists polled by Bloomberg.
In terms of commodity imports, iron ore exports from Australia and Brazil to China have been healthy, hitting 16.3 million and 5.0 million tonnes respectively, but there’s a potential issue. Chinese northern mills’ steel margins have shrunk to 0-30 yuan for the last three months, setting up a potential issue for steel mills to balance input and output prices all the while with the knowledge that a new outbreak could potentially shut operations at short notice.
Casting your mind back to the start of the pandemic where it seemed that China had managed to deal with the virus well, one would quite easily have opined then that come today the Chinese economy would be roaring back into action and continuing its incredible rise to be the de facto largest economy in the world. What we find ourselves actually with is a stuttering return to normality. If you are a producer or transporter of resources to China this conundrum for the country should be a worry, all it will take is a new wave of infections and commodity prices and rates could go plummeting, while Chinese exports prices could soar.
Issues in China don’t just cause problems for raw material producers, but also others. Take battery metals for example, a key commodity for the future of industry and the economy, as the world attempts to transition away from its reliance on oil produced energy and toward renewables. Around 90% of the world battery metals are currently processed by the country and without any further development by other countries combined with the ever-present threat of supply disruption through lockdown, things could get pretty tight on the supply side.
The war in Ukraine has already changed trading patterns, especially the grains trade, which needed to adapt to a significant supply disruption. It is not unreasonable, therefore, to conclude that a similar adaptation with respect to China may need to be made.
The question is how long will the Chinese disruption continue? The longer it continues the greater the internal dissenting voices within the Communist Party as Xi Jinping attempts to remain in power indefinitely. So too will there be greater impetus for the rest of the world to divest away from its dependence on China.
With a falling birth rate and, although not officially recognised yet, shrinking population, is this China’s Suez Canal Crisis moment, pre-empting their decline now that the veneer of unending yearly growth has cracked?
All that is clear is that the pandemic has forced a change to the settled global economy and globalisation. Risky stormy seas are ahead and safe harbours few and far between.