China exerts a massive amount influence on commodity markets. It is said to account for 40 percent of base metal consumption and 23 percent of major agricultural commodities, according to an IMF working paper by Shaun Roache. It's an even bigger market for commodities than the U.S.
And since a Chinese hard landing isn't completely off the table, it's worth considering how this would impact commodities.
In a new note titled "What If China Lands Hard?" Societe Generale's head of commodities research, Michael Haigh writes, that a Chinese hard landing would both lower demand and hurt investor confidence, thereby delivering a double blow to the price of commodities.
In a hard landing scenario, some expect all commodities to plunge uniformly. Even gold prices could plunge because China is the second largest consumer of gold.
However, gold's reaction is not so obvious.
Haigh writes, that the impact on gold was the most difficult to forecast. Their model suggests that a significant drop in Chinese PMIs (which they use as a proxy for a hard landing) would send gold prices surging 15 percent in the first quarter after a hardlanding to $1,963 per ounce. Gold he points out would be the only commodity to experience this initial rally.
But it would also decline rapidly after.
This fall would be triggered by three key things:
- A strengthening of the U.S. dollar in a risk off environment that would cause gold prices to decline because it is priced in dollars.
- Easing concerns about inflation.
- A rush to cash that would see a move out of long gold positions.
Patrick Legland, head of research at Societe Generale wrote that investors polled on the impact of a Chinese hard landing on commodities and stocks were most uncertain about the impact on gold price.
The average response was for a 5 percent decline, while Asian investors in particular expected a 21 percent decline. A third of those polled thought gold prices would rise in a hard landing scenario.
As for Dr. Copper, it is more sensitive to Chinese PMIs than U.S. PMIs considering China consumes five times as much copper as the U.S..
"Importantly, copper prices no longer lead PMI movements, but follow them," according to Haigh. "This means we can use our economist’s 3% Chinese hard landing GDP scenario – which implies a 40% drop in PMIs - to forecast the demand shock impact on commodity prices..." In this scenario, copper prices are projected to fall from $8,000/tonne to about $4,500/tonne one quarter after a hard landing.
Base metals as a whole are projected to decline about 50 percent. Zinc prices are expected to fall to $1,150 per tonne one quarter after the Chinese hard landing, from $2,010/t. Lead prices are projected to fall to $1,250/t, from $2,283/t. Nickel is projected to fall to $10,000/t, from $17,190/t. Finally, tin is projected to fall to $12,000/t from $23,743/t.
Meanwhile, oil is projected to drop to about $77 per barrel one quarter after the Chinese hard landing, from current price of about $111 per barrel.
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