Prices for commodities from Nickel to Copper and crude oil to iron ore have slumped over the past week.
Futures prices for nickel fell 9% in a single day, Crude saw prices decline 6%. What is notable is that physical commodity markets like iron ore have also seen wild gyrations, with benchmark ore prices slumping by 10% on Wednesday alone, totally at odds with underlying fundamentals.
China’s equity market has lost almost a third of its value since mid-June. The slump, initially triggered by a tightening in margin requirements continued to fall as authorities appeared to be relaxed by the falls.
Up until today efforts by authorities had failed to buck the trend. Today (Thursday), Chinese shares saw their biggest jump in six years rising by 6% as authorities boost scrutiny of short selling.
However, although scant comfort for any private investor drawn in at the top of the market, the slump needs to be seen in context. Even after the recent fall the Shanghai Composite Index is still up over 120% compared with twelve months ago.
Some fear that the slump will exacerbate the slowdown in the Chinese economy as households that have been wiped out by the slump retreat from spending. At the very least, slowing the transition towards a more consumer orientated economy.
If you assume that commodity prices just reflect underlying demand and supply for their end consumption then recent falls appears unjustified. The link between declines in equity values and commodity consumption remains tenuous. Even so, the brief time in which share prices have fallen is not enough to have a significant impact on consumer spending.
The bigger driver of the commodity price fall is likely to have been the use of commodities, especially industrial metals as collateral to finance equity purchases. In the past a wide range of commodities have been used as collateral, including iron ore, soybeans, palm oil, rubber, zinc, and aluminum, as well as gold, copper, and nickel.
Some reports suggest that privately owned Chinese steel mills are being forced to stop purchasing new iron ore and liquidate inventories to cover losses made in the plummeting equity market.
“If steel isn’t making any money, they look elsewhere. That place had been equities. Until now.”
This isn’t the first time that fears over China’s use of commodities as collateral has led to sharp drops in commodity prices. Back in early 2014 copper futures prices dropped sharply following China’s first domestic bond default.
Chinese authorities plunge protection have relieved the slump in equity prices for now. But, further falls could lead to more unwinding of collateral borrowing, putting further downward pressure on commodity prices.