Over the past 15 years, China’s impact on global raw material demand has been nothing short of phenomenal.
The spectacular growth in commodity demand between 2005 and 2010 led to the term “commodity supercycle”.
But this was no ordinary commodity cycle, as the nation with a population of more than 1 billion people rapidly urbanised.
Today, despite the slowdown in commodity demand since 2011, there are still many analysts who have the firm conviction that the world remains in a commodity supercycle and that the globe is currently experiencing a pause before the acceleration in the demand for commodities resumes.
Bearing these views in mind, as well as the current impact on global markets being caused by China’s growth slowdown, it is worth taking a moment to review the impact of China’s industrialisation and the rapid increase in commodity demand in the past.
Equally important is taking stock of current commodity demand fundamentals and looking to the future and China’s likely impact on commodity demand.
The death of Chinese communist leader Mao Zedong in 1976 saw the end of the Cultural Revolution and the introduction of economic liberalisation in the Chinese economy. This change in economic policy led initially to a period of gradual industrialisation followed by a phase of rapid acceleration of the economy, with an emphasis on fixed-asset investment.
Economic acceleration
In the 1980s economic growth accelerated off a low base, gathered further momentum in the 1990s and, in the 2000s, the Chinese economy grew rapidly during a time of loose global monetary policy and excessive credit extension.
Evidence of this industrialisation is illustrated by the growth in China’s commodity demand.
In the 1980s and 1990s the demand growth for commodities such as steel, aluminium, copper, zinc and nickel expanded at less than 10 percent a year. However, in the period between 2000 to 2010 demand for these commodities increased between 12 percent and 20 percent a year.
This rapid increase in demand caught the companies that produce commodities flat-footed and scurrying to increase production by investing heavily in mine expansions and new mine development.
The fruits of these investments are only now coming into full production and this is one of several reasons why there is currently an oversupply of many commodities.
This, in turn, has placed downward pressure on commodity prices.
The evolution of the Chinese economy and its impact on commodity demand can be seen in terms of China’s share of global commodity consumption.
If the 20-year period from 1994 to 2014 is examined, the following statistics stand out:
In 1994 China’s share of global commodity demand was less than 10 percent.
By 2004 China’s share of commodity demand had increased to about 20 percent, with the exception of steel, which stood at 28 percent.
Ten years later, in 2014, China’s share of commodity consumption had accelerated even further to 45 percent for copper and zinc, and about 50 percent for aluminium, nickel and crude steel.
Accordingly, commodity demand and prices are largely dictated by the ebb and flow of the Chinese economy.
If one examines China’s share of commodity demand growth for this year, the percentages are increased.
For commodities such as copper, aluminium, thermal and metallurgical coal, zinc and lead, China’s share of demand growth is forecast at between 60 percent and 80 percent.
For steel this number is a staggering 95 percent.
Despite China’s dominant position in terms of global commodity demand, over the last five years there has been a concerted effort to swing the Chinese economy away from investment in infrastructure development and real estate, to a consumption driven economy.
Regardless of these efforts, China’s ratio of fixed capital formation to gross domestic product (GDP) remains stubbornly high, at 50 percent.
A reduction in gross capital formation investment will inevitably result in slower GDP growth in the future.
This transition to a consumption-led economy has negative consequences for commodity demand.
Notwithstanding this negative commodity demand outlook, continued Chinese urbanisation should provide support for commodity consumption – although not at past growth rates.
At present China’s population is 55 percent urbanised compared with the US at 80 percent and Japan at 90 percent.
For the next few years the commodity complex faces headwinds from China.
Not only is the rate of economic growth contracting but the intensity of fixed-capital formation in the economy is slowing.
Passing the baton
Consequently, there is a structural decline in commodity demand growth.
The requirement for bulk commodities – including coal, iron ore and steel – will be the most adversely impacted by the slowdown in the rate of growth in fixed-asset investment.
Copper and aluminium prices should fare better than the bulk commodities as they are not as negatively affected by a reduction in spending into large capital projects.
So who will take up the commodity mantle from a slowing Chinese economy?
Based on population demographics and rates of urbanisation, the commodity baton should be taken up by emerging market economies such as the Association of Southeast Asian Nations, India, the Middle East, Africa and Latin America.
The increasing demand from these economies will not necessarily offset the slowdown in demand from China, however it will soften the blow.
These emerging market economies together represent about half of the world’s population.
These population demographics are indicative of the fact that there should be significant support for commodity demand over the next 10 to 20 years.
The metals commodity basket is entering a very different era to that of the 2000s. The Chinese economy is deliberately moving away from an infrastructure-led to a consumption-driven economy.
This will impact commodity exporting nations negatively as they will be pressured to find alternative forms of economic growth.
The rapidly urbanising emerging market economies will incrementally shift commodity demand away from China and will take market share away from the “global factory”.
As a result of this shift in urbanisation, the intensity of commodity cycles should diminish as global demand is spread across a great number of industrialising economies.
Tony Cadle is the head of portfolio construction at Ashburton Investments.