While commentary on recent price movements acknowledges China as the key driver in global commodities, there are other factors that influence the direction of the markets in both the short and long term.
These issues are in danger of being overlooked in the rush to credit the country with all the growth in the past two decades and blame it for the slowdown.
Broadly speaking, macro factors play into the long term, micro or fundamental issues influence the medium term, and currency, technical and behavioural factors feature in short-term movements.
Commodity markets are notoriously volatile and prone to long cycles, and this was the case well before China became an important driver.
Latterly, the nation has been consuming more than half of most global metals production, as well as being a major producer of some.
On balance China is an importer of iron ore, copper, nickel and zinc, as well as agricultural commodities. Its intensity of commodity and energy use is falling as it moves into a lower phase of growth trajectory.
Commodity prices respond to currency moves and are denominated in US dollars, so a strengthening dollar implies lower prices.
The devaluation of the Chinese renminbi matters, as do falls in the currencies of major emerging market energy and commodity producers, such as the Brazilian real and Russian rouble.
The supply of commodities tends to be capacity constrained and inelastic in the short term and more flexible in the long run. This means that without clear visibility on future demand and a long lead time, markets can be over or undersupplied, often for protracted periods.
In time, production can be expanded or alternatives found to meet rising demand and higher prices, while high-cost capacity should be squeezed out in response to falling demand.
The degree of competition varies considerably between commodity markets – from those dominated by a few large, low-cost producers, such as iron ore, to the much more competitive, like copper or agricultural commodities.
There are a range of fundamental, technical and market factors to weigh up for investors in commodity companies.
Key differentiators are the structure of the markets concerned, micro factors such as where businesses sit on the cost curve, how much inventory they are holding, how leveraged they are and how quickly they adjust production in response to changing demand.
Commodity assets can become ‘stranded’, where the cost of production exceeds the price, but profit does not motivate all producers.
Ultimately, investors care whether companies can fulfil obligations – that is, pay interest on debt and disburse dividends to equity holders.
In spite of moderating demand, quantitative easing and ultra-low financing costs are helping to prolong the adjustment process.
Generally, excess supply should see convergence between prices and cost curves, but inventories are not particularly high for many commodities.
Investors themselves have played a significant role in the sector’s markets and have contributed to volatility in the past decade.
