In early May I highlighted some of the potential China related risks facing commodity investors. One of the stories that was not on many investors radar was the Winter Olympics – due to be held in Beijing in February 2022. To see why this is important you only need to look back at the last time China staged the Olympics in August 2008.
A construction boom ahead of the games plus precautionary imports of vital commodities (for example, diesel to avoid the risk of power shortages) were major factors behind the final surge in the late 2000’s commodity super-cycle.
In early April, four months ahead of the event, Chinese authorities imposed all manner of restrictions on industrial activities in order to cut pollution. The list of planned restrictions announced included:
- Digging and pouring of concrete on construction sites suspended from July 20-Sept. 20
- Any construction projects not scheduled to have completed excavations and concrete placement as well as site “greening and coverage” by July 20 not allowed to start work.
- Heavy-polluting companies to cut their emissions by 30% from July 20-Sept. 20
- Coal-burning boilers that fail to meet emission standards will be closed.
- Production would be stopped at cement plants, concrete mixing plants, and cement grinding plants in south eastern Beijing.
- Quarrying operations to stop.
- Gas stations, oil depots and tanker trucks would cease operations unless equipped with “oil vapor recovery” technology,
- More than half of Beijing’s 3.5 million cars and trucks to be off the road for the full duration of the Olympics.
- Five provinces and municipalities surrounding Beijing (city of Tianjin; Hebei, Shanxi and Shandong provinces and Inner Mongolia region) to shutter factories.
The announced restrictions marked the high point in commodity prices. Copper prices peaked in early May at $4.28 per lb with iron ore topping out at a little under $200 per tonne. The Baltic Dry Index peaked at around 12,000 a couple weeks later in the month. The price of Brent crude meanwhile reached record levels a couple months later around when it hit $147 per bbl.
Now, a little over four months ahead of the Winter Olympic opening ceremony, the pattern is repeating. China is once again launching directives all over the country to cut polluting and energy inefficient activities. The first target for the authorities has been the country’s steel sector. China’s Ministry of Ecology & Environment said in a draft guideline issued this week that it plans to involve 64 regions under key monitoring in the winter air pollution campaign.
What happened to commodity prices in 2008? Oil, copper and iron ore fell between 60 and 75 percent between May and December 2008, while the BDI declined by 95 percent.
The timing of China’s commodity boom and bust coincided with the near collapse of the global financial system. The first bad signs began to emerge in the spring of 2008 before eventually snowballing into the Great Financial Crisis (GFC) later in the autumn. Valuations across commodities and other asset markets collapsed as investors panicked.
But investors shouldn’t disregard the timing of the two events as merely coincidental. The dramatic rise in commodity prices that occurred in the preceding years – most notably in the aftermath of Hurricane Katrina in 2005 – were contributing factors to the unsustainable build-up in leverage that eventually had to be unwound.
Over the past 12-18 months commodity prices have seen a dramatic surge in value as a rebound in demand has hit a wall of largely unresponsive supply. When already high commodity prices proceed to spike to ever higher levels that often marks the point at which something, somewhere breaks. In 2008 it was the global financial system. Will 2021 be different?