Commodities Skid on China’s Stock Rout

Whoops. Aivars Lode

By Tatyana Shumsky

Commodities suffered their worst rout in seven months as a steep selloff in China’s stock market magnified investor fears about weaker demand from one of the world’s largest consumers of raw materials.

The S&P GSCI, an index that tracks a diversified basket of commodities, fell 4.9% to 412.51 Monday. This was its steepest drop since November and its lowest level since April. The losses come amid a swift downdraft in Chinese stocks, which have lost more than one-quarter of their value since touching a record high in June and gave up 72% of all their gains made this year.

Commodity traders fear that China’s tumbling stocks reflect broader economic weakness. Chinese shares vaulted 60% to a record high on June 12 as Beijing unleashed a flood of cheap money in its effort to prop up indebted businesses. The government’s efforts to restructure China’s economy toward domestic consumption, and away from export-led growth, have taken a toll on economic expansion. China’s annual economic growth has slowed to 7% in the first quarter, from nearly 9% at the start of 2012, as manufacturing activity contracted and property prices fell.

Oil prices posted their steepest drop in three months. U.S. benchmark light sweet crude oil for August delivery settled down 7.7% to $52.53 a barrel on the New York Mercantile Exchange, its biggest daily drop since Feb 4 and its lowest level since April 13. The losses in oil come as inventories in the U.S. surprised higher last week and as a potential deal over Iran’s nuclear program threatens to unleash additional energy supplies on the global market, traders and analysts said.

Copper prices slumped by the most since January, with September-delivery futures closing down 3.5% at $2.5380 a pound on the Comex division of the Nymex.

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Soybeans fell 1.1% to $10.33¾ a bushel, a one-week low, on the Chicago Board of Trade. Cotton prices fell 0.7% to 66.95 cents a pound, a six-session low, on the ICE Futures U.S. exchange.

“We’re getting greater signs of stress in China and typically when you see that, you see weaker economic activity” and commodity demand, said Michael Strauss, chief investment strategist with Commonfund Asset Management Co., which manages $25 billion.

Mr. Strauss has held a smaller exposure to commodities than recommended by diversified asset indexes, and said the recent downdraft in Chinese stocks reinforced his conviction that there is more trouble ahead for commodity prices, commodity producers and economies of resource-producing countries.

The drop in Chinese stocks comes amid heightened concerns about corporate profit growth and after share prices skyrocketed in response to government measures to cut borrowing costs. Many investors worry that China’s stock market is in a bubble fueled by cheap money, and that as the bubble deflates and share prices fall, the losses will trigger bankruptcies in China’s financial sector that will further sap growth.

“There will be repercussions [for commodities] given how many millions of people opened accounts and started buying stocks,” said Edward Meir, senior commodities strategist with brokerage INTL FCStone. “When your stocks account is getting crushed, you’re not going to go out and buy that washing machine…it’s all related,” he said.

Investors rushed out of commodity markets in response, cutting back holdings of energy, metals and grains.

Nicholas Robin, who helps manage $600 million invested in commodities at Columbia Threadneedle Asset Management in London, said his fund has held less copper than suggested by commodity indexes on the belief that demand would continue to disappoint.

“Metal demand is already not so good [because] the property market in China hasn’t been doing well,” Mr. Robin said, adding that recent gyrations in Chinese stocks suggest the economy there is likely to remain weak, reducing the country’s copper purchases further.

Commodity markets have been under stress for weeks as investors worried that lackluster global growth would translate into weaker appetite for resources such as crude oil and copper. Supplies of many raw materials are projected to run ahead of global demand this year, putting pressure on prices.

China’s efforts to stabilize its stock market are coming against a backdrop of a debt crisis in Greece, which is dulling the impact of the measures, said Bart Melek, senior commodities strategist with TD Securities in Toronto. Some investors are worried that credit problems in Greece will affect Europe’s economic performance, slowing the region’s growth and demand for raw materials, he said. Another concern is that demand for Chinese exports will fall further as Europe’s economy slows, he said.

“Greece, from a demand perspective, doesn’t matter, but it is impacting sentiment and risk appetite…it’s creating uncertainty and loss of risk appetite,” Mr. Melek said.

To be sure, some investors say the current pullback in commodities makes this a good time to buy resources on the cheap, and that prices should recover as global growth picks up next year.

“The demand picture will improve next year and we see further stability in China,” said Paul Christopher, global market strategist, Wells Fargo Investment institute, with $1.7 trillion in assets under management. Mr. Christopher has been telling clients to slowly add commodities back to their portfolios, after holding less of the asset class than prescribed by diversified asset indexes in recent years.

But other investors say it’s too early to return to commodity markets.

“We’re not there yet, given the challenges in Europe and the challenges that are resurfacing again in China,” said Commonfund’s Mr. Strauss.