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06 January 2016

China Disappointment

“This is the way the world ends. Not with a bang but a whimper.” Those two lines (from ‘The Hollow Men’) are probably the most quoted extract from T S Eliot’s poetry, but actually I suspect that when most of us use them, we misquote as “not with a whimper but a bang” - somehow, the bang seems more significant than the whimper. Eliot was probably having a dig at the Versailles Treaty, of which he seriously disapproved. Anyway, a bang not a whimper is how the year in the financial markets has begun, courtesy of further disappointing economic statistics from China. Thus, the China Composite was halted after dropping around seven percent on the first trading day of the year, followed by the major European indices, New York and LME metals.

Haunting the World

That phrase, “further disappointing economic statistics from China”, looks like it is going to haunt the global economy for some time still to come. That is somewhat disappointing, given the efforts made by western (and in that I include Japanese, despite the geographical inexactitude) governments to boost their own economies and rescue them from slump. I have been quite critical of those efforts - particularly QE - in this column over the last couple of years, and I am still by no means convinced of it as a long-term solution to anything. However, by its own lights, one has to acknowledge a degree of success; problems which were imminent are now rolled further into the future, and frankly that was the intention. The objective of most governments is to push difficulties forward, ideally beyond the next election, so they don’t disturb the (comfortable) status quo. That may not be their intention in the first enthusiasm of their electoral success, but experience suggests that it soon becomes so. So, and I know the debt hawks - who sometimes write on here as well - will disagree profoundly with me, I would suggest that that first objective has been achieved. Yes, there is still a mountain of debt weighing on the world’s shoulders and at some point it will have to be addressed, but, pace gold-standardistes and monetary purists, right now the world is robust enough to hold it.

In Thrall to China

The immediate problem, as I see it, is contained in that phrase about China. Unfortunately, the world is still in thrall to Chinese growth and sadly not comfortable with indicators which suggest that it has failed to meet expectations. Rather, then, than debt mountains it is the failure of the world so far to deal with its disappointment about China’s slowdown that is the driver behind the weakness in financial markets. For sure, as the second-largest economy, China is of vital interest, but my concern is that too much reliance has been placed on it. 

And the LME...

To move from the general to the particular, this is also the problem facing the LME as the year begins. The ‘road-map’ (which, incidentally, is a really irritating phrase in this context: thanks, G. Bush and T. Blair) shows a highway leading to greater liquidity, volume and profitability, but I would argue that it is also too reliant on one input. Right now, the traditional metal trade - the underlying raison d’être of the LME - is not having a good time. Prices are low, demand is stagnant, production is only very slowly beginning to be brought into line with demand. That is an environment in which it is unrealistic to look for substantial growth in LME usage. At the same time, the commodity sector - as an investment prospect - is right up there with the least popular. Although there have been a small number of new hedge funds - or new to the sector - on balance, they are reducing not adding to their exposure. We are all learning that when the banks said during the boom ‘commodities are a sector to which you must have exposure’, they meant, ‘when prices are going up’; flat or dropping prices do not attract investment. So at the same time that the trade is unlikely to be boosting its LME activity, the same goes for the hedge fund sector, and, by extension, a great deal of other investment money. 


Where, then, is the new volume demanded by the road map to come from? Well, probably where it’s always been said - from opening up the market far more to China. That’s a laudable intention, and logical given the LME’s current ownership; of course that would be the way to go. Thing is, though, in the current environment I don’t think it works. It’s something else that was predicated on Chinese growth. And when the tide finally does turn, I expect equities to outperform commodities as cost-cutting takes effect before the world’s glut of metals (and oil) is used up. So if I had one prediction for this year, reluctantly it would be that LME volumes are unlikely to increase as desired. Like the world as a whole, the LME hasn’t yet adjusted to the reality of what is happening in China.

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