China’s economic growth stokes commodity bulls as risks grow

By Clyde Russell/Beijing

Chinese wait at an intersection for the green light next to a new, massive residential construction site in Beijing. China’s rapid growth slowed in the latest quarter

China’s stellar second-quarter economic growth should come with a health warning similar to investment products: past performance isn’t an indicator of future returns.The commodity bulls will have been stoked by the 9.5% growth in gross domestic product in the three months to June.Not only did it beat expectations of 9.4%, the details were positive, showing a 15.1% rise in factory output and record steel production.Certainly, the case for a soft landing for the world’s fastest-growing major economy is still very much in place.In such a scenario, demand for key commodities, such as crude oil, copper, iron ore and coal should remain robust, supporting higher prices in the second half of the year.Investors responded to the China data by boosting the prices of metals, shares and the Australian dollar, a key risk-barometer currency.But – and this is a fairly big but – the happy story presented by China may be adversely affected by developments half way across the world.The debt crisis in Europe just seems to get worse and it now appears likely there will be a default of some sort on Greek debt, with heightened risks of something similar in Ireland, Italy and Spain.An emergency summit of European Union leaders on Friday will attempt, once again, to stop the contagion.But the track record of European leaders shows muddling through is their preferred response to the crisis, which isn’t the solution markets would like to see.If, as seems increasingly likely, private investors are asked to share in the losses from restructuring some European debt, the implications are profound, maybe even enough to send the region’s economy back into recession.The US won’t escape from this either as financial markets once again threaten to become seized and any messy outcome in Europe will undermine an already fragile US recovery.In this scenario it’s hard to see how China and the rest of Asia will avoid slowing economic growth.Of course, China and some Asian countries have the ability to turn on the fiscal tap and boost infrastructure spending, a move that would help keep commodity prices buoyant.But China’s biggest export destinations are Europe and the US, and if consumers once again feel threatened in these regions, they will lock away their wallets and stop buying China’s consumer goods.The China PMI for June showed some of this threat, with the index for new export orders dropping to 50.5 in June, below the overall PMI of 50.9 and just above the line separating expansion from contraction.If the world doesn’t buy as many Chinese goods, China isn’t going to need as much iron ore, coal and copper. It may still need more crude, but expectations of 8% demand growth this year may be optimistic if the developed world sinks under the weight of its debt crisis.There is another risk to the bullish view, in that China may not have finished its monetary tightening in the light of its stronger-than-forecast GDP growth.If the authorities were expecting the economy to cool more than it has, they could take the view that another hike in rates is needed.Of course, if Europe’s woes get worse and last week’s weak US jobs numbers are a harbinger of more gloom, China is unlikely to tighten monetary policy.Nonetheless, it now appears that the bullish case for commodities is increasingly reliant on Chinese demand, which in turn is becoming more reliant on developments in Europe and the US.