China slowdown and interest rates hit commodity markets

May has, so far, been a terrible month for commodities and follows a dramatic April in which oil prices made double-digit losses.

Oversupply and faltering demand growth have made oil prices more volatile over the last year or so, than at any time since the financial crisis of 2008. Prices for other commodities, including copper and gold, are also falling.

The main two reasons for this recent weakness – particularly for industrial commodities – is the combination of two economic factors from the world's two biggest economies, the US and China.

Fed hawks circle

In the US, signs of a strong pick up in growth during 2016 and its resultant impact on the US labour market and inflation, have led to the Federal Reserve becoming more hawkish in its stance on monetary policy.

By February the Fed had raised its main interest rate twice from its historical low of 0-0.25%. The first increase, in December 2015, took the rate to 0.25-0.5%, then a year later it was lifted to 0.5-0.75%.

Federal Reserve chair Janet Yellen - source: Wikimedia Commons

Commodity investors fear interest rate rises, as any economic cooling that results from higher rates, crimps demand for raw materials and energy.

The central bank's board members started to prepare the ground for March's rise, which took the rate to 0.75-1%. Fed chair Janet Yellen said such a move was "appropriate", while erstwhile policy dove Lael Brainard, on 1 March, said "it will likely be appropriate soon to remove additional accommodation, continuing on a gradual path".

Commodity correction

Some commodity prices, including oil and copper, had hit their year highs in February, but were soon about to embark on a reversal that took some into correction territory – a correction is officially entered when an asset's price falls 10% below its last cyclical peak.

Since hitting its year high in February, the Bloomberg Commodity Total Return index is down 8.3% – 4.7% since April 13.

Brent Crude, the benchmark oil price, is down 15% since its February peak and is down 13.2% since 13 April, while Comex Copper is down 11.5% since its February peak. Gold's fall has only recently begun, but is down 5% since 13 April.

The losses are such that funds are scything their exposure to commodities.

Copper prices have been hit by falling Chinese exports - source: Pixabay

Funds cut commodity exposure

Saxo Bank reports that hedge funds are slashing their bullish commodity exposure, with the energy sector the worst hit.

Ole Hansen, head of commodity strategy at Saxo Bank, says: "Hedge funds cut bullish exposure across 23 US-traded commodity futures and options by 12% or 92,000 lots in the week ending 2 May."

He adds: "The energy sector was particularly hard hit with oil longs cut by 20% – just before the slump – to the lowest level seen since November 29, 2016."

China crisis

Copper prices began their latest slide in April after data began to indicate slowing growth in China, as purchasing manager indexes in manufacturing and construction fell.

China is an important driver of sentiment for industrial metals and was the keystone of the so-called "metal supercycle" seen during 2011-12, and copper fell nearly 2% on Monday after data showed a slowdown in Chinese copper imports.

"China's import of unwrought copper dropped 30% in April from March to a six-month low," says Mr Hansen.

He continues: "This comes on top of last week's weakness which was driven by rising LME inventories and Chinese monetary tightening raising concerns about housing demand as the impact of the 2016 infrastructure surge begins to fade."

Andrew Kenningham, chief global economist at Capital Economics says: "Slower growth in China will have important consequences for some commodity-dependent economies. We have argued for some time that the prices of industrial metals were vulnerable to a slowdown in demand from China, which accounts for half of global consumption of many metals."

On Monday, the worst performing stocks on the FTSE 100 were copper miners, with Anglo American and Antofagasta both down 2%, while Glencore fell 1.6% and Rio Tinto lost 1.5%.