It’s the best of times in commodities markets, it’s the worst of times in commodities markets.
Iron ore jumped by the most on record on Monday, while Brent crude broke through $40 a barrel for the first time in three months. Then Chinese export data Tuesday showed dollar- denominated shipments falling 25 percent, the worst decline since May 2009.
What is going on?
There are reasons to take both sets of data with a pinch of salt. Market prices are prone to speculation, momentum trading and short squeezes, all of which could explain some of the movement in iron ore and oil.
Economic indicators can also be tricky. How much of China’s export collapse in February had to do with the timing of Lunar New Year? If exports to Hong Kong were inflated in December by fake invoicing, is it bullish for the yuan that they declined to a six-year low in February?
Here are five indicators worth watching for a clearer picture on where commodities are headed.
The Baltic Dry Index
You can ignore the hyperbole about the Baltic Dry being a sort of barometer for the global economy. But to understand the state of real commodities demand, it’s invaluable. A benchmark for rates to charter the ships that carry iron ore, coal, and grain, the index is currently at particularly depressed levels thanks to a global glut of cargo capacity. As it tracks real prices being paid to book ships, there’s no speculative element. If real demand starts to pick up from Chinese consumers, the Baltic Dry will be one of the first places it shows up.
Cement Prices
One of the reasons cited for iron ore’s surge on Monday was news that China’s National People’s Congress was prepared to accept a larger budget deficit to keep the economy humming along. The post-2008 building boom showed that China’s leaders were prepared to use the construction industry as a tool of economic management in much the same way as Western central banks use debt markets. If Janet Yellen says the economy is looking weak, you’d do well to buy U.S. Treasuries. If Chinese leaders say the same thing, pile into construction materials. It’s possible that the surge in iron ore is showing the smart money betting on renewed construction stimulus. For a gut check, look at cement prices: Buildings can’t be started without pouring concrete, and until that measure starts to pick up, it’s worth being skeptical of the iron ore contract.
Chinese Electricity Production
Chinese economic numbers are so unreliable that even Chinese leaders don’t always believe them. While working as a party boss in northeastern Liaoning province, Premier Li Keqiang is said to have told a U.S. diplomat that he ignored GDP data. His favored indicator has been dubbed the Li Keqiang Index, a growth measure tracking bank loans, rail freight volumes, and electricity production. The latter may be the most worthwhile indicator. Bank loans aren’t such a great guide because of the splurge in shadow banking, and rail freight volumes are released with a lag. Electricity production is timelier, and hard to fake as a guide to real economic activity.
Chinese Refinery Utilization
Tuesday’s Chinese trade data suggested a positive demand outlook for oil, with a net 31 million metric tons of crude and refined products entering the country in February, in line with December’s record net import figure. Still, the picture is muddied by fuel flowing into public and private stockpiles — the country’s strategic petroleum reserve, currently being built out, is intended to hold about 100 days’ worth of imports by 2020. A useful cross-reference may be weekly run rate data, a measure of how Chinese refineries are operating relative to capacity limits. In the U.S. and India, refinery utilization is typically above 90 percent, or even more than 100 percent. China’s plants habitually operate at lower utilization rates and will be affected by Lunar New Year, but until this series starts to pick up it will be hard to be too bullish about real oil demand.
Japan Thermal Coal Contract Price
While China has overtaken Japan as the world’s largest coal importer, the contract prices Japanese utilities strike with Australian thermal coal producers in early April remain an important global benchmark. That’s because, as with the Baltic Dry, they’re pretty much quarantined from speculative activity: The contract represents agreed prices for a year’s worth of coal between a real producer and a real consumer. Generally, they price some way above market-traded prices such as ICE’s Newcastle Coal futures, but the degree of premium gives a clue to where the big players see markets heading. Chinese port inventories are dwindling, which could be bullish or bearish for coal, depending on your priors. The price at which the Japan contract settles will provide ammunition for one view or other.
Waiting for confirmation of your hunches is a good way to miss out on an upturn in the market, so there’s a lot to be said for putting some faith in the wisdom of crowds. But it’s always worth checking speculative moves against more fundamental indicators. As the U.S. economist Paul Samuelson almost said, markets managed to predict nine out of the last five commodity booms.
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