Barron’s on Tuesday called it “the crash you didn’t hear”.
They were referring to the sell-off in the Thomson Reuters/Jefferies CRB index, which dropped 2 per cent and hit a seven-month low on Monday, after falling some 10 per cent in the past month.
As Barron’s notes, the so-called crash has affected commodities from copper to crude oil to corn, and prices have been tumbling for the better part of a month. They link the fall primarily to the resurgence of the dollar.
But, they add, the sell-off could now be accelerating:
The commodities decline has been overshadowed by news of the European debt crisis, the oil-spill disaster in the Gulf of Mexico and the flash crash which caused a thousand points of fright in the Dow Jones Industrials a couple of weeks ago. But the slide in commodities has been picking up speed in the last week and, anomalously, has come against the backdrop of soaring gold, which hit a record price in dollars of $1,249 an ounce last week.
Here’s a quick recap of the performance in some of the key commodities mentioned:
The slide in non-ferrous metals like copper can of course be linked to China’s endeavours to cut industrial overcapacity in the country.
As Barclays Capital, for example, noted on Monday — the effects of the government’s measures this month have already been far reaching:
Chinese authorities made their starkest demonstration yet that they plan to tackle overcapacity in the aluminium industry by announcing a series of measures last week. The first was a doubling in power prices which overnight has raised costs for up to 35% of global production and could threaten the closure of up to 2.7Mt of capacity, according to our estimates. With immediate effect aluminium smelters, which account for c.6% of total Chinese electricity consumption, are to no longer receive power discounts and will see electricity prices double from RMB0.05/KWh to RMB0.10/KWh.
Local governments will also be allowed to implement further increases. We estimate that this will increase production costs by up to 5%, $110/t, and will result in many higher-cost smelters making a loss at current prices. Smaller smelters are typically the oldest and most inefficient, often using 15MWh/t, while newer smelters’ power consumption can be as low as 13MWh/t.
We estimate that around 2.7Mt of Chinese capacity is made up of smelters below 150Ktpy, which could be at risk from closure following the energy price hike. Closures will help to bring capacity back in line with consumption, but with 3-4Mt of new capacity slated to come online in the next couple of years the closure of high-cost capacity is unlikely to tighten spot supply for more than a brief period. This is, however, clearly demonstrative of the upward pressure on the industry cost curve.
But, we would point out, it’s not like the China effect wasn’t flagged up. Sean Corrigan of Diapason Commodities, for example, wrote back in March that investors were increasingly positioning for a sell-off in energy products.
The question now is at what rate, if any, the sell-off continues.
And so far, on Tuesday at least, commodities have been rebounding.
Related links:
Reining in the Chinese inflation dragon – FT Alphaville
China tightening? Yeah right. – FT Alphaville
Is China on the verge of a commodities unwind? – FT Alphaville
What really drove Chinese commodity imports? – FT Alphaville