- Financial Times – China commodities tumble after US tariffs, steel prices weaken sentiment
Futures contracts for key commodities were tumbling in China on Friday and Australian mining stocks plunged to a two month low amid weakening sentiment after US president Donald Trump formally adopted a 25 per cent penalty on steel imports and a 10 per cent penalty on aluminum imports. Futures contracts for one tonne of iron ore – a key steel making ingredient – sank as much as 5.7 per cent on the Dalian Commodity Exchange in China, according to Wind data. Other commodities were hit with the futures contract for coking coal down 3.3 per cent and that for copper off 2.1 per cent. Wood Mackenzie analyst Rohan Kendall attributed the fall in iron prices mostly to softer Chinese steel prices but suggested the tariffs were playing a part.
- Business Insider – Iron ore is getting walloped
The benchmark price has now fallen in seven of the past eight trading sessions, losing nearly 8%.Iron ore spot markets were hammered on Thursday, logging the largest decline so far in 2018. And with futures markets falling again overnight, the downdraft may not be over yet. According to Metal Bulletin, the spot price for benchmark 62% fines tumbled 3.4% to $73.23 a tonne, the largest percentage decline since December 27. The benchmark price has now fallen in each of the past five sessions, and in seven of the past eight, leaving it sitting at the lowest level since February 1.
Summary
Short swings in industrial metals prices garner headlines but have an overstated reputation for predicting big changes in global economic growth. Agricultural commodity performance has improved in 2018, supporting estimates for global economic growth above 3%. Even though commodity performance has been in a sweet spot for global economic growth, markets have good reasons for watching industrial metals.
Comment
We tend to downplay big swings in industrial metals, such as copper’s dramatic fall and then equally dramatic rally in December, as having real predictive value for the economy. Short-term swings in volatile markets make for better headlines than barometers. But on a longer time horizon, we’ve found year-over-year commodity returns are useful in predicting global economic growth.
We built a generalized additive model to estimate global economic growth using rolling yearly returns for S&P 500 commodity subclasses. The chart below shows world GDP growth (blue) and the model estimate back to 1996. Year-over-year performance in commodities points to global economic growth near 3.3%, slightly below the median estimate of 3.7% according to Bloomberg.
A closer look at rolling yearly returns for the subclasses shows improvement in agricultural commodities has been the story of 2018. Rising alongside energy, strengthening agricultural commodities are pointing to solid global growth.
One of the advantages of a GAM model is we can see how each component of the model affects the output. Below we show the smooth functions for the response, the prediction for world GDP, as the year-over-year return for each class of commodity changes. Hashed lines reflect the current values, which are standardized yearly returns.
Livestock and softs are in a sweet spot of year-over-year performance with both pointing to solid growth. Livestock performance is near the best possible in terms of its influence on economic growth. Softs are interesting in that very stable returns are most favorable for growth while even mild changes become growth headwinds. Other agricultural commodities only tend to influence global growth estimates at extremes.
The next chart shows why markets have tended to over-predict changes in growth from changes in industrial metals prices. These are the same charts showing the effect on the global growth rate estimate given changes in the year-over-year returns for industrial metals (left) and energy (right).
Industrial metals performance is strongly positively correlated with growth, but the latest performance still points to solid economic growth. How these markets respond to rising trade tensions will be critical for global growth, even as the individual impacts on specific nations will vary widely. Rising prices are still supportive of global growth but the steeper slope to the left shows its contribution to the growth estimate falls quickly as performance deteriorates.
The chart on the right also shows how the global economy is more resilient to modest changes in energy prices than some might think. Higher energy prices are a modest headwind, falling energy prices a modest tailwind. Only at the extreme do we see negative impacts from falling energy prices.
Conclusion
We will stick to our story about markets typically reading too much into short-term swings in industrial metals prices. For now, stronger performance in agricultural commodities is helping strong 3+% global growth estimates despite minor turbulence in industrial metals. But over the longer term, how industrial metals respond to rising trade tensions will be crucial for global economic growth. Remain calm and keep watching China.