Soft China purchasing managers’ index increases stimulus hopes

A weak Purchasing Managers’ Index (PMI) in China is often viewed as a buy signal for industrial metals such as iron ore and copper, as investors take the view Beijing will boost stimulus spending. Problem is, the evidence for this is mixed.

The official PMI dropped to 49.5 points in August, down from 49.7 in July and marking the fourth month in a row that it was below the 50 level that demarcates expansion from contraction.

The ongoing and escalating trade war with the United States takes much of the blame for the softness in the PMI, and the outlook is further clouded by a new round of tit-for-tat tariffs that took effect on Sunday.

The market consensus is that the continuing weakness in China’s key manufacturing sector will prompt the government to roll out more stimulus, most likely through increased infrastructure and construction spending, and easier credit.

The Caixin/Markit Manufacturing Purchasing Managers’ Index (PMI) for August rose to a five-month high of 50.4 from 49.9 in July, after two months of contraction. But the detail was not quite so bullish: new orders only picked up marginally and companies had to cut prices in order to win business.

Spot benchmark 62 per cent iron ore for delivery to north China, as assessed by commodity price reporting agency Argus, jumped 5.8 per cent on Friday to end at $86.25 a tonne. It moved higher even before the release of the downbeat PMI on Saturday as investors anticipated more stimulus in the pipeline.

Iron ore is still down from its peak this year of $125.20 a tonne, reached in early July amid a supply crunch caused by mine closures in Brazil in the wake of a fatal dam burst and a tropical cyclone that idled some production in top shipper Australia.

The disruptions in the two biggest iron ore exporters also account for most of the decline in China’s imports of the steelmaking ingredient this year, down 4.9 per cent in the first seven months of the year compared to the same period in 2018.

However, in prior episodes of weak PMI outcomes, it’s difficult to see conclusive evidence that this has resulted in a boost to iron ore imports in anticipation of stimulus spending, despite this view being widely promulgated among market participants.

When the PMI dropped to 50.3 in February 2018 from 52.4 in September 2017, iron ore imports were effectively tracking sideways even though month-to-month swings were quite volatile.

A recovery in the PMI from February 2018 to a peak that year of 51.9 in May 2018 wasn’t accompanied by rising iron ore imports — they were actually weaker on a year-on-year basis.

As the PMI starting weakening from May last year onwards, iron ore imports also weakened, further undermining the view that a softer PMI results in a boost to iron ore on the back of stimulus spending.

For copper the correlation between the China PMI and imports is also unconvincing, with imports of unwrought copper essentially tracking sideways since 2017 even as the PMI showed fairly large swings between expansion and contraction.

If import volumes don’t seem especially correlated to movements in the PMI, how do prices respond?

Discounting this year’s supply-driven price gains in iron ore, and there have been some occasions when prices rose as the PMI was declining.

However, a stronger correlation would appear to be seasonal, with iron ore prices tending to rally for restocking as winter ends and during the summer construction peak.

For copper, the Shanghai futures contract tends to rally when the PMI is accelerating and decline when the PMI drops. That’s not unusual given copper’s heavy use in manufacturing.

However, a rapid fall in the PMI doesn’t appear to cause copper prices to gain in anticipation of increased government measures to boost the economy.

The PMI slumped from 51.9 in May last year to 49.2 in February, but copper futures also dropped over this time period.

Overall, it appears that while anticipation of stimulus spending on the back of a weakening PMI may drive prices for a day or so, it doesn’t appear to be a reliable indicator of the longer-term demand for imports, or the future price.

Nickel prices in Shanghai hit a record high on Monday, while they jumped to a five-year high in London, after top producer Indonesia said it would restrict ore exports from 2020.

The benchmark three-month contract was up 3.2 per cent at $18,470 a tonne, as of 0349 GMT, its highest since September 2014, while Shanghai nickel surged to its maximum daily limit of 62 per cent to a record 136,960 yuan ($19,309.72) a tonne.

Reuters