Hard landing for commodities as China slows

By Vikram Barhat | March 7, 2012 | Last updated on March 7, 2012
3 min read

Experts are calling the recent tumbling of commodity prices and resource-related equities an overreaction to China’s lowered growth forecast.

One of the biggest buyers of Canadian commodities, China officially revised its gross domestic product growth target on Monday to 7.5%, triggering a slide in commodity markets.

While the market had been expecting slower growth, China’s official announcement raises the stakes, said Paul Taylor, CIO, BMO Harris Private Banking.

“It is an important signal to the market and one that’s not been lost on the Canadian equity market, which is taking it on the chin,” said Taylor adding that “market is probably over-adjusting to the news.”

The chances of a China hard landing is very slim, he added.

“It’s typical of Chinese officials to under-promise and over-deliver,” he said. “Growth in the range of 7.5% and 8.5% will have to be characterized as a soft landing which [will be] extremely supportive of copper, nickel, gold and oil prices; all of which are produced in abundance here in Canada.”

There’s no disguising the strong connection between commodity prices and China, but the latest growth forecast hasn’t come as a surprise to the street, says Gareth Watson, vice-president, investment management and research at Richardson GMP in Toronto.

“China’s currently transitioning to becoming an economy that not only is reliant on exports, but also one that sees organic growth through domestic consumption,” he said.

And because that process takes time, there is a larger play at work, he added.

“It’s not just a question of our commodities going up and down in terms of China’s economic growth, [it’s about] how they’re positioning their economy for the future, which bodes well for the Canadian economy.”

The short-term ebbs and flows aside, in the longer-term there is potential for an even greater economic boom in emerging markets than what the West saw post-World War II, said Watson.

However, there is more trouble brewing for the commodities market: Iran’s threat to block the Straits of Hormuz, a key oil route in the Middle East, which could have a profound impact on the world’s crude oil market.

Watson says while it is difficult to quantify that risk, the biggest threat comes in the form of higher oil prices at a time when the global economy is relatively fragile.

The global economy was choked last year by a spike in oil prices, caused by the Arab Spring movement, which weakened growth in emerging markets. Another surge in crude oil prices could potentially wreck havoc on global markets.

Industry watchers assure such an outcome is highly unlikely, though.

“If Iran blocks the Straits of Hormuz, it’s going to get completely blown away,” said Watson. “No one’s going to stand around and [let them do that].”

The last time Iran delivered on that threat was in the early 1970s, when the Shah annexed three islands in the strait. That closure lasted seven months—this time it may not even last for seven hours, says Watson.

Be that as it may, the price of crude oil already reflects a meaningful war premium on it, says Taylor, who admits that if the strait closes, the global economy will suffer and oil prices could hit record highs.

“It’s definitely a wild card that’s popped up quite quickly and it is a meaningful issue that we have to consider very carefully,” said Taylor.

In the extreme event that Iran repeats the1970s adventure—which was also done in retaliation to a trade embargo—the price of a barrel of oil, at least by one account, could soar to $440 a barrel.

Vikram Barhat