China’s various purchasing managers’ indexes gather significant attention as indicators of the health of the world’s second-biggest economy, but they are less useful as a predictor of commodity imports. The official Purchasing Managers’ Index (PMI) fell to a 3-year low of 49.7 in August, in line with market expectations and down from a reading of 50 in July.
The drop below the 50-level that separates expansion from contraction will be viewed as another sign that China is struggling for growth momentum, and raises further questions over whether 2015’s official target of a 7-percent increase in gross domestic product can be realised. The Caixin/Markit PMI dropped to 47.3 in August, the weakest since 2009 and down from 47.8 in July. The official PMI focuses on large, state-controlled companies, while the Caixin/Markit measure encompasses more small- and medium-sized enterprises.
In theory, the weakening of the PMIs should spell gloom for commodity import volumes, but it may not be as dire as feared. While PMI readings below 50 are certainly a negative for China’s commodity demand, history suggests that the prevailing price and stockpiling demand are more important drivers of imports.
At the beginning of 2013 the official PMI was at 50.4 and it climbed as high as 51.7 in July 2014 before weakening to 49.8 in January this year, rallying a tad to 50.2 by May and then dropping to the current low. In other words, the PMI has traded either side of the 50-level, with the trend being downwards for the past 12 months. In contrast, imports of crude oil have been trending higher since the start of 2013, rising from 25.15 million tonnes in January of that year to 30.71 million in July this year, the third month in the past eight where they have topped 30 million.
Over the same period, iron ore imports have also been trending higher, jumping from 65.54 million tonnes in January 2013 to 86.01 million tonnes in July this year. Whilst it is true that iron ore imports are showing no growth in the first seven months of the year compared to the same period last year, the point is that they are tracking up at a far higher level than they were two years ago, whilst the PMI has gone sideways and weaker. There appears to be a far stronger correlation between iron ore imports and the spot price in Asia.
At the start of 2013, iron ore was at $144.90 a tonne, and since reaching $158.90 in February that year, it has trended downwards, dropping to $55.70 on Monday. While iron prices did decline over 2013, the pace accelerated in 2014, and it was also then that China started ramping up more of the steel-making ingredient. The lower price of iron ore was prompted by the massive expansions of mines in Australia, but the Chinese response was to buy more as their own mines reduced output as they slipped into losses.
With crude oil, imports again surged in 2014 and have maintained momentum this year, after Brent crude fell dramatically from July 2014 onwards, after a period of relative stability in 2013. Brent lost as much of 63 percent of its value between late June 2014 and the recent closing low of $42.69 a barrel on August 24. The sustained lower price has coincided with China boosting imports in order to fill strategic storage, suggesting that price has been a factor in increasing purchases as it’s possible that if crude had remained at elevated levels, the Chinese could have deferred purchases until they deemed the price was more competitive.
What the numbers show is that the price appears to be a bigger determinant of China’s commodity imports than the level of the PMI. Of course, this doesn’t apply evenly to all commodities, take coal for example. Imports have weakened considerably this year even though the price remains depressed, but this is likely more due to a structural shift lower in China’s demand as Beijing battles pollution and seeks to limit the use of dirtier fuels. But overall, commodity imports are likely to hold up as long as prices remain relatively low and the Chinese economy does record growth, even if that growth is soft as indicated by the PMIs.
