Market Views: Is copper signalling a sell-off in risk assets?
Falling copper prices in 2018 have triggered concerns about what that might mean for commodities markets and risk assets.
The price of the widely used industrial metal has declined by about 16% since early June, with market observers attributing the downward shift to slowing Chinese demand as US-China trade war concerns escalate and drag on the global economy.
“Metal prices are discounting a 25% chance of a recessionary event being triggered by trade frictions and that compares with a much, much lower number two-three months ago,” London-based Bernstein analyst Paul Gait was quoted arguing last week by Reuters.
The broader concern is that falling Chinese demand for copper due to slowing economic growth and the impact of US tariffs could be the canary in the coalmine for global equity markets and a flashing indicator that investors should reduce their exposure to risk assets.
China accounted for approximately half of all copper consumption worldwide in 2017, driven by growth in the construction and manufacturing sectors, as well as government investment in the national power grid system, according to a January commodities bulletin by consultancy KPMG.
However, overall Chinese economic growth is slowing, from 6.9% in 2017 to an expected 6.4% in 2019, according to the latest IMF World Economic Outlook report. Official Chinese data for the second quarter just gone shows the economy grew at its slowest quarterly rate since the third quarter of 2016.
Adding to the downward pressure is the growing trade friction between the world's two biggest economies, the latest salvo being Washington's 25% tariff announcement on $16 billion-worth of Chinese imports on August 7.
We asked a commodities head of a wealth manager, an economist, and three multi-asset specialists what the falling price of copper means for commodities and markets generally, and whether investors should cut back their exposure to risk assets.
The following extracts have been edited for brevity and clarity.
Dominic Schnider, head of commodities and forex CIO for Asia-Pacific (Hong Kong)
UBS Wealth Management
Despite the recent price correction, we believe investors should not position for weaker broad commodity prices or falling equity markets.
We attribute last month’s copper price decline to two developments: weaker Chinese economic data and escalating US-China trade tensions. China is at the heart of worldwide copper consumption, accounting for roughly half of global offtake. Any indication that China's economy could weaken casts a shadow on metal prices, as seen from the slide in all industrial metal prices since mid-June. However ... we haven't seen a corresponding rise in copper inventories at exchanges. This suggests to us that most of the weakness is ... speculative-driven on expectations of softer physical demand.
The reassessment of China-linked risks due to President Donald Trump's escalating trade policies has impacted not just industrial metals, but asset markets more broadly, predominantly in China and the rest of Asia. The Chinese yuan has devalued sharply since June, with Chinese and Asian equities bearing the brunt of investors' heightened risk aversion and demand for greater risk premiums. This cannot be said for the US or European equity markets.
In our base case, additional US tariffs could ultimately be applied to most, if not all, US-China trade, as well as to autos and auto parts shipped between the US and its trading partners. Needless to say, investors should brace for more tensions ahead. With this outlook, we reduced our overweight position on global equities. Within Asia, we reduced our overweight on Asia ex-Japan equities to neutral given the market's more direct exposure to global trade tensions.
That said, we still believe that the Chinese equity market, which is at the centre of trade tensions, is attractive with solid earnings growth prospects and very reasonable valuations. This stance, along with our expectations for higher commodity prices, reflects our view that despite ongoing trade concerns, global economic growth will stay above trend, at around 4%, as we head into 2019. We therefore think a modestly risk-on asset allocation is appropriate. We see ... value in Asian high-yield bonds offering yields of around 8%.
Investors more concerned about President Trump's foreign and trade policies could engage in oil-linked investments (direct or via equities) to diversify their portfolios. Renewed US sanctions on Iran put oil supplies at risk, making a greater market deficit in the next 12 months more likely; we expect Brent crude oil prices to reach $85 per barrel in 6-12 months. An alternative is to hold the classic long Japanese yen or long gold position as an insurance against serious risk-off events in financial markets.
Guillermo Felices, senior portfolio manager for multi-assets, quantitative and solutions (London)
BNP Paribas Asset Management
[Investors should not reduce risk assets] for now as at this point in the cycle risky assets, notably equities and commodities, typically do well. We see two salient risks to our constructive macro base case: higher-than-expected inflation and a significant global slowdown. These risks merit some protection in multi-asset portfolios with long risk exposures like ours. For example, long [Japanese yen] positions, as a hedge against a global slowdown and protectionism, and underweight government bond exposures in core sovereign markets, like Germany or the US.
Copper prices have fallen materially and probably more so than the medium-term fundamentals suggest. We don’t have long copper positions currently but prices are starting to look interesting. The same can be said about other China-linked assets that have been de-rated because of protectionism and weaker China growth, like Chinese stocks.
Copper is dropping mainly because of slowing Chinese aggregate demand and fears about trade wars between the US and China. Copper was a big beneficiary of China’s aggressive credit stimulus in 2015-16, and that is now fading away. This should not be taken as a bellwether for other commodities to suffer as the global cycle is still strong. The fall in copper is quite China-centric (a reflection of both slower growth there and trade war risks) and it does not really mirror the strength of demand elsewhere. US growth, for example, is strong and other cyclical assets that hinge on it, such as US equities and [high yield] credit, have done well in recent months.
Copper prices are sensitive to China prospects. If China’s economic slowdown or fears related to protectionism derail global growth, then it could spill-over to other cyclical assets. But we don’t think that will be the case as the Chinese authorities have plenty of room for counter-cyclical policy. On the protectionism front, we think the stakes for the US and China are too high for a full-blown trade war.
Paul Hsiao, economist (Hong Kong)
Sunny Ng, portfolio manager for global multi-asset (Hong Kong)
PineBridge Investments
The decline in copper has been a victim of the risk-asset sell-off rather than a leading indicator. The movement in copper prices has coincided with similar weakness in emerging market assets. Emerging markets have had a challenging year so far, amidst the re-emergence of US dollar strength and rising tariff talk. For many asset classes, this re-rating has made valuations a lot more attractive after a broad risk asset rally last year.
The decline of copper prices this year has two components to it. The first is that supply growth has modestly rebounded from a contraction last year. Perhaps, more importantly, has been the unwinding of demand expectations, which has not only hit copper but the broader industrial metals market as well.
Since China has been the world’s largest copper consumer, expectations of slower growth on the back of a more vigorous deleveraging campaign may have contributed to the metal’s price decline.
The return of copper prices to their levels in early-2017 should show that much of the impact from issues like trade tariffs, as well as softer Chinese data, should already be priced-in. The fundamental picture for many economies around the world looks better than it did last year when there was a substantial risk-asset rally. Much of this market sell-off is happening at a time where we expect global growth to reach the highest point so far this cycle. Looking ahead, the re-synchronisation of growth or resolution of the trade spats should drive risk assets higher.
Investors need to be selective during this time. An array of cross-currents confront global markets, but on balance, they appear positive – providing opportunities. While trade-related risks have risen, valuations have reset, financial conditions remain accommodative, and China has provided a growth backstop. We [remain] constructive over the intermediate term and maintain our above-neutral risk positioning. Trade will remain the dominant short-term risk for markets, although we see it morphing into a positive force for global growth ... We still believe that revisiting the global trading regime, despite producing short-term tensions and more incremental tariffs than we expected, ultimately will lead to ... lower overall trade barriers.
Until then, the risk to watch is the degree of trade-tension spill-over into corporate confidence, which could mute or even derail the next investment-driven leg of global growth. It’s still early, but the spill-over risk may be contained by indications that companies are able to re-route supply chains relatively quickly. Overall, while strong earnings growth globally marked the first half of 2018, markets have sold off since February. Together, this has compressed valuation multiples. To our eye, it is the sustainability of above-average growth that markets are mispricing most.
Kelly Chung, senior fund manager (Hong Kong)
Value Partners
The current copper price has already priced in a quite pessimistic demand outlook. However, we think it should find support in [the second half of 2018] [since] global economic growth remains strong and China is ... easing policy, particularly on infrastructure. In the near-term, how the trade war unfolds ... will continue to bring uncertainties to the macro outlook. But on a medium term horizon, [given] the demand and supply fundamentals have remained largely unchanged and the copper price is likely to benefit from rising inflation as the global expansion goes on, we still maintain a general positive view of the metal.
... While we believe that the two sides will resolve the trade dispute through negotiations eventually, fear and uncertainty in financial markets will linger and investors may continue to feel the pinch ... China’s deleveraging policies will burden its GDP growth in the short term, but we believe that China’s policy makers will remain flexible and constantly fine-tune policies to avoid a sharp deceleration in economic growth. [Worth noting too is that] the US dollar, which generally has an inverse relationship with commodities, appreciated about 5% against both developed-market and emerging-market currencies in [the second quarter].