Steeling themselves

Why Chinese steel overcapacity will continue to test global steel producers’ patienceSince 2010, Chinese demand for steel has lagged far behind production and exports (Figure 1). In spite of this, production has remained strong with steel mills taking advantage of low iron ore prices at present. These sustained levels of production have been worrying producers of the metal around the globe as China ships its excess steel abroad. China is already the world’s largest steel manufacturer, in value terms they dwarf the whole of North America and are estimated to be responsible for around 50% of global overcapacity. Steel associations outside of China argue that China is flooding markets and hence driving steel prices down.  As a result of these concerns, eight representatives of steel organisations from around the globe (North America, Latin America and Europe) have lobbied China to alter its recent Steel Adjustment Policy 2015.

 

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Figure 1  | Chinese Steel Exports and Imports, demand and production compared, based 2010
Source | DeltaMetrics 2015

 

Chinese iron and steel trade is highly correlated with the value of the yuan (and with equity markets across the region). Further, its trade generally is also highly correlated with the Iron and Steel price. Through a state-controlled steel industry, China is able artificially to drive down steel prices and effectively circumvent the market forces which all other global steel industries are susceptible to. The eight steel association representatives therefore hope China will rethink its steel policy for the benefit of the free market and the future of steel trade.

Delta Economics, sees encouraging signs of China reining in its steel exports in future. Between 2010 and 2015 (to the current month), we saw a compound average growth rate (CAGR) in Chinese steel exports of 10.7%. This was compared with 5.3% growth from North America, 1.3% in Latin America and 1.5% in Europe over the same period. However, between 2015 and 2020 we are now forecasting significantly lower CAGR growth in Chinese steel exports of 6.8%. This is compared with growth in steel exports in Latin America (4.2% to 2020), North America (6.2% to 2020) and Europe (2.6% to 2020). It appears, therefore, that China may well be listening to global concerns over its steel overcapacity.

This will not be a quick or easy process, however. It will take years of adjustments to address the Chinese steel surplus. Smaller steel mills within China are most likely to bear the brunt of the readjustment policy with plant closures and redundancies. However, the larger steel mills will be slower to change. Therefore, although our forecasts are showing more encouraging signs for steel producers outside of China, the coming years are likely to severely test the industry.

 

 

Nerves of steel  |  Author  |  Jack Harding  |  Analyst and Publications Manager

Growth, currencies and interest rates

Four trade challenges to monetary policy  |  Short summary:

 

The Fed needs to be careful about the next monetary steps it takes because:

  1. The growth effects of Quantitative Easing (QE) in Europe are yet to be felt, if indeed they will be
  2. Neither China nor Korea’s trade surplus with the US is the Fed’s biggest concern in emerging Asia
  3. The weak yen is not boosting Japan’s exports to the US and is not responsible for its surplus
  4. Monetary policy is not the answer to trade and growth imbalances, but has unintended consequences

 

Context

In its bi-annual report to Congress, the US Department of the Treasury, International Affairs, assessed the macroeconomic policies of its major trading partners to see if inappropriate activities are being used to manipulate the balance of trade with the US. It urged the governments of Germany, China, South Korea and Japan to do everything in their power to eliminate global economic imbalances by focusing on reducing their trade surpluses with the US and halting practices of competitive devaluation against the US dollar. Against a backdrop of strong US growth and weaker growth elsewhere, the report argued that addressing these imbalances through structural reform, monetary and fiscal policy was the only way of ensuring that the G20 balanced global growth targets were met.

 

Four trade reasons why monetary policy alone can’t create real growth:

 

1  |  The growth effects of QE in Europe are yet to be felt, if indeed they will be

The immediate effect of QE has been to push European equity markets to new highs and push down the value of the euro against the USD. It is unlikely to create real, export-led growth since the correlation of the euro with Europe’s trade is positive (i.e. an increase in the value increases trade). Where it does have an effect on boosting trade, it is likely to be felt most strongly in Germany. This will potentially exacerbate the problem of its trade surplus, particularly with the US (Figure 1).

 

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Figure 1  |  Monthly Value of German Exports to the US (USDm), June 2001 – December 2015 vs. EUR-USD, Last Price Monthly, June 2001 – March 2015
Source  |  DeltaMetrics 2015, Bloomberg

 

The chart shows a positive correlation (0.67): in other words, as the value of the euro increases, so too do exports. This reflects the relative exchange rate inelasticity of trade between Germany and the US. Growth in exports from Germany to the US has been modest over the past two years and the sharp reduction in the value of the euro does not appear to be likely to make much difference to its trade balance with the US.

The weaker euro is unlikely to impact Europe’s or, more specifically, Germany’s trade surplus with the US. Indeed, it is also unlikely to lead to greater demand without an accompanying non-monetary policy in Europe, such as infrastructural spending and structural reform to boost both demand and competitiveness.

 

2  |  Neither China nor South Korea’s trade surplus with the US is the Fed’s biggest concern in emerging Asia

The yuan is kept within a 2% peg of the US dollar and, as such, has been increasing its value since the end of 2004 when the currency was first allowed to float. More recently, March 2015, the yuan has appreciated against the US dollar giving rise to speculation that the peg is about to be loosened or removed completely (Figure 2).

 

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Figure 2  |  Monthly Value of Chinese Exports to the US (USDbn) vs. USD-CNY Spot Price, Last Price Monthly, June 2001 – December 2015
Source  |  DeltaMetrics 2015, Bloomberg

 

The impact of the appreciation of the yuan is to suggest that Chinese exports to the US may flatten slightly during 2015. This provides some cause for optimism around the size of its trade surplus with the US. Of greater concern from a US perspective may be Russia’s decision to price oil and gas deals with China in yuan. This suggests that the yuan’s role as a trade finance currency is growing and that there will be further strengthening of the currency. This is likely to be a result of both a loosening of the peg and the role of the yuan as a trade finance currency. The threat of a stronger yuan and the prospect of a future currency war may be more unpalatable than the trade surplus now.

The won is slightly different in that it is only very weakly correlated with South Korea’s exports to the US at -0.46. In other words, any devaluation by the Korean monetary authorities is unlikely to have much, if any, impact on its trade surplus with the US. Given the speed that the Kospi has picked up since QE in Europe has prompted greater liquidity, the US would do well to look at the consequences of capital outflows and rising dollar-denominated debt as Asia’s slowdown works through. Priced in local currencies, such as the won, the markets look buoyant; priced in dollars, the rises are less substantial and represent both a loss in earning and pose a threat when dollar-denominated debt has to be repaid.

 

3  |  The weak yen is not boosting Japan’s exports to the US and is not responsible for its surplus

Japan’s QE programme has resulted in a substantial devaluation of the yen against the US dollar. However, this has not had the desired impact of increasing all exports to the world or the US in particular (Figure 3). Export-led growth has not materialised despite substantial QE-induced devaluation since the onset of Abenomics.

 

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Figure 3  |  Monthly Value of Japanese Exports to the US vs. USD-JPY Spot, Last Price Monthly, June 2001 – December 2015
Source  |  DeltaMetrics 2015, Bloomberg

 

In fact, if anything, exports to the US from Japan have been falling ever since the start of the most recent phase of QE in Japan. Alongside this, Japan’s imports from the US have been increasing and could grow by nearly 5% in 2015 as a result of Japan’s greater external energy dependency after Fukushima.

 

4  |  Monetary policy is not the answer to trade and growth imbalances, but has unintended consequences

The US Fed is now in a bind: its challenge is not the monetary policy of its trading partners, it is the unforeseen consequences of its next monetary moves. The US dollar is strong and while some of this is because the US economy itself is doing well compared with other economies, its strength is more than partly due to the fact that markets are speculating on when the Fed will put up rates. Fuelled by both QE and uncertainty around the announcement of a rise in rates, it is likely that the USD and the euro will reach parity imminently, if not by the end of April then during May. Similarly, the yen is hitting new lows against the USD.

The euro and the yen’s values are already distorted by the effects of QE. Alongside this, any increase in interest rates will exacerbate the dollar’s strength against the currencies of all its major trade partners except China. While currencies weaken, equity markets including the Dax, Nikkei, the HSI and the Kospi continue bull runs that are the direct result of large amounts of liquidity made cheaper, not just by low interest rates, but also by weaker currencies. The result will undoubtedly be aggravated by a rise in US rates: a strong US dollar is not necessarily the best for the US in the long run if corporate earnings, confidence and exports falter.

Webcast 032 | Resurgent dollar is not good for business

The US Dollar has strengthened in March: Rebecca Harding discusses the consequences of a potential rise in US interest rates on emerging markets and the rise of the yuan as a major trade currency.

 

Webcast 032 Author  |  Rebecca Harding  |  CEO

Gold Trade: Why high demand for gold may be a good thing for India

Much of the recent attention regarding gold trade has been directed at China. This is entirely justified; rapid gold purchases from around the globe have fomented speculation that China is preparing to float its currency. But the truth is no-one really knows what they are planning to do. Their strategy is a manifestation of Deng Xiaoping’s famous maxim “hide your brightness, bide your time”. In other words, they will not show their strength until they can ensure they will achieve their objective.

Ambiguity and speculation over what is, undoubtedly, a very important question for global markets has meant that gold trade in other, highly significant, consumer nations has slipped under the radar. India, for example, currently ranks top in terms of largest gold consumer nations and in the past few years there have been shifts in policy.

Gold is an extremely popular commodity in India; it is as much a symbol of affluence as it is a means of providing future security. Demand for the precious metal has remained high. However, in recent years, India has struggled to balance this demand with its large trade deficit.

Policy makers were so concerned with the overall trade imbalance that in August 2013 the so-called 80/20 rule was imposed. This rule restricted India’s gold imports and forced 20% of any gold shipment to be re-exported by Indian jewellers. The 80/20 rule was scrapped in November 2014 after it became apparent that the domestic jewellery sector was suffering (Figure 1). Policymakers within India instead decided to focus on boosting exports rather than curbing gold imports.

 2015-03-25_CommentsAnalysis_016_IndiaGold_fig01_v01

Figure 1  | India gold jewellery market, 2008 – 2015, the impact of the 80/20 rule
Source | DeltaMetrics 2015

 

This is potentially a very shrewd shift in strategy; Delta Economics does not expect India’s demand for gold to abate with a forecast compound annual growth of 9.5% to 2020. Therefore, instead of cutting gold imports, which was leading to an increase in smuggling, February 2015’s budget suggested a scheme to monetise Indian citizen’s private gold holdings: an estimated 20,000 tonnes. The scheme would allow Indian citizens to accrue interest on any gold deposited into the banks. This could, as a consequence, reduce volatility in the rupee and provide the average Indian household with extra spending power.

At a time when the world’s national banks seem to be realising the potential of having a gold-backed currency, India’s historically high demand for gold suddenly doesn’t seem like such a bad thing.

 

Gold Trade: Why high demand for gold may be a good thing for India  |  Author  |  Jack Harding  |  Analyst and Publications Manager

Gold Standard

Three links that show the Yuan is ready to float  |  The value of the yuan against the US dollar is not making the headlines it should at the moment. Between the 17th and 20th March it appreciated by nearly 1%. Much of this volatility was arguably a response to the Federal Open Market Committee’s (FOMC’s) removal of the word “patient” from its statement on US interest rates. However, between the same dates, gold prices increased by nearly 3% prompting China to announce that the value of its currency against the US dollar was “appropriate”.

The occurrence of these three things within a week does not look like a coincidence, especially given that the Asian Infrastructure Investment Bank, first conceptualised in October 2013, acquired the support of the UK government, some European governments, the IMF and the Asia Development Bank during March 2015.

As China’s economy rebalances and becomes demand-led rather than export and infrastructure driven, it is in China’s interests to support trade in its neighbouring countries. This allows the region as a whole to develop by picking up some of the intermediate manufactured goods production that China can re-distribute through its own supply networks as it moves further up the manufacturing value chain.

Markets are markets and it is a mistake to conclude much from a few weeks of data. Yet it has shown how the re-focusing of China’s currency policy could have global market consequences. Currency policy is currently hidden within a multitude of different signals which appear to have converged during early March. China’s policy makers may be showing that they want to expose the yuan to international markets as they prepare for capital account convertibility. But they have also shown that they are preparing the yuan to establish itself in trade finance and indeed international markets as the second global currency.

There are three reasons for stating that the yuan is strengthening as a global currency: the first is trade, the second is the link between trade and the value of the yuan and the third is the link between gold and the value of the currency.

First, the link between trade and gold in China’s case is clear. Figure 1 shows how gold prices and China’s trade have moved together since June 2001 with a correlation of above 90%. The movements were almost identical up to the end of Q3 2013 when China’s trade starting slowing, de-coupled for 12 months to the start of Q4 2014 and have been similar for the last four months. February’s drop in gold prices mirrors China’s drop in trade and while this is clearly not causality, the closeness of the correlation is important.

 

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Figure 1  |  Monthly Value of Chinese Total Trade (USDbn) versus XAU-USD Gold Spot Price, June 2001 – March 2015
Source  |  DeltaMetrics 2015, Bloomberg

 

Second, the correlation between Chinese trade and the value of the currency is similarly high at nearly 95%. However, interestingly, against the USDCNY spot (where strengthening of the yuan is shown by a downward trend) the correlation with Chinese trade is negative. In other words, despite a perception that the yuan’s value is artificial because of its 2% peg against the US dollar, the mild appreciation of the yuan since 2005 has not had a detrimental effect on trade (Figure 2). What this suggests is that the peg is helping to shore up the currency’s strength as trade develops rather than being managed to shore up trade.

 

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Figure 2  |  Monthly Value of China’s Total Trade versus USD-CNY Spot, Last Price Monthly, June 2001 – December 2015
Source  |  DeltaMetrics 2015, Bloomberg

 

Further evidence of this is shown in the third link: between the value of the yuan and China’s trade in gold. The correlation is nearly 80%: that is to say that as the exchange rate has moved, so gold trade has increased (Figure 3).

 

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Figure 3  |  China’s Gold Trade (USDm) versus USD-CNY Spot Price, Last Price Monthly, June 2001 – December 2015
Source  |  DeltaMetrics 2015, Bloomberg

 

Three things are immediately striking about Figure 3: first, gold trade only really started when the currency first appreciated against the US dollar; second, gold trade spiked when the initial 1% peg against the dollar was introduced in 2012; third, imports of gold started to increase sharply again from Q2 2013 as pressures for reform grew and the country prepared for its 18th CPC Central Committee Meeting in November 2013.

 

What all this suggests is that China’s currency policy is apparently a great deal more coordinated than it might appear at first. It is impossible to know exactly how much gold the country has and the values of trade in physical gold also underestimate total trade in gold which may come from barter or alternative forms (such as jewellery). However, alongside the increase in recorded trade in gold, China has been reducing its foreign currency reserves. This suggests that there is the potential for a large currency shift away from the dollar towards the yuan. The fact that gold reserves are increasing while foreign exchange reserves are falling suggests that policy makers are less concerned about weak Chinese growth and exports as they are about ensuring that, when the time is right, the yuan can enter a free-float against the dollar with impunity.

The links between trade, the yuan and gold all point in one direction: expect the gold price to increase, the yuan to strengthen and China’s exports to increase. China’s economy does not look like it is slowing – but it could just be setting a new Gold Standard.

Fed-up?

Three reasons why the Fed should not raise rates  |  The rampant US dollar went relatively unnoticed until the end of last week as the world’s attention was diverted towards Europe and the start of Quantitative Easing (QE). It gained almost 4% against the so-called “BRICSA” and “MINT” currencies, the South Korean won and the Thai baht in the first two weeks of March. Since these countries have almost $US 870bn in dollar-denominated debt, all of a sudden the dollar’s strength appears to be the world’s weakness in the long term. And as markets are increasingly expecting a small increase in US interest rates in June, the Fed should at least consider the international consequences of that decision.

Quite apart from anything else, it highlights just how integrated the post-crisis world is through the global financial and trading systems and, increasingly, monetary policy as well. At its extreme, there is no such thing as “national” monetary policy: Central Banks, including the Fed, do not set interest rates for a closed economy. Their actions have global repercussions and at no time in recent economic history has this been clearer as June, and therefore the prospect for a hike in Fed rates, gets closer.

Delta Economics is of the view that if the Fed raised interest rates it would be damaging the prospects for long- term economic growth in the US. This is not because the US economy is weak. Rather, it is because the risk of sovereign default on the dollar denominated debt becomes greater as the dollar gets stronger. Beyond the simple cost of repayment, there are three things that make default likelier and therefore the consequences for the US economy more severe.

 

1. Currency depreciation does not necessarily lead to export growth

First, it cannot be assumed that there is an automatic link between currency depreciation and greater exports. The Thai baht, for example, shows how for some countries there is an inverse relationship between the currency’s value and its trade: as the spot rate decreases (in other words the baht appreciates) trade increases (Figure 1a). This is also the case for some of the other, most indebted, Emerging Market economies: for example, Brazil ($188bn debt), China ($213,7bn), South Korea ($82.3bn) and Thailand ($14.6tn) (Figure 1b ).

 

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Figure 1a  |  Monthly value of Thailand’s exports versus USDTHB, Last Price Monthly, June 2001-Dec 2015 (forecast)
Source  |  DeltaMetrics 2015, Bloomberg

Figure 1b  |  Selected Emerging Market currencies’ correlation with trade growth, June 2001-March 2015
Source  |  Delta Economics analysis

 

Conversely, the positive correlations are not as strong as they should be for a country to benefit from a depreciation in its currency. For South Africa and Russia there is a very low correlation indeed, while for Indonesia, India and Turkey the correlations are higher but still moderate. Only Nigeria and Mexico have stronger correlations between the value of their currency and trade. This suggests that they are in highly competitive markets (such as oil and intermediate manufactured goods) where the responsiveness of trade to a change in the value of the currency is likely to be higher.

However small a rise in Fed interest rates may be, the dollar’s value would increase and therefore make emerging market debt more expensive. Because there is not a clear-cut and positive impact on trade, Emerging Market economies are unlikely to have the export-led growth effects that will make that debt affordable.

 

2. Oil Price Losers

The dominance of oil in the structure of Emerging Market trade is made obvious by the extraordinarily high correlation between oil prices and total trade (Figure 2).

 

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Figure 2  |  Correlation of total trade with oil prices, selected Emerging Market economies, June 2001-March 2015
Source  |  Delta Economics analysis

 

The lowest correlation of trade with oil price is China at 0.81, but for countries like Indonesia and Mexico the correlation is much higher at 0.90 and 0.89, respectively. What this suggests is that trade will increase as oil prices rise and vice versa. This is simply a reflection of the importance of oil in the structure of trade of Emerging Economies: because of its dominance, its correlation with the price of oil is very strong.

But because of the oil dependency of trade for many Emerging Markets, the fact that trade will drop in real terms means that all nations are potential losers from the fall in oil prices. This is either because their revenues from oil exports have dropped or because their trade overall has dropped. Again, this makes it tougher for any export-led growth to materialise.

 

3. Over-valued EM equities

The story of Emerging Market equity growth in the period since the financial crisis is one of expectations exceeding outcomes. The extraordinary recovery of trade and economic growth after the crisis pulled capital into Emerging Markets in anticipation of growth in the future. The strong correlation of most Emerging Market equities with trade through the 2001-2015 period illustrates the strength of these expectations manifested in investments in Emerging Market equities.

 

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Figure 3  |  Correlation between emerging market equities and exports, June 2001-March 2015
Source  |  Delta Economics analysis

 

Interestingly, only China and Nigeria exhibit weaker relationships between their markets and trade. However, China’s trade is 0.94 correlated with the Hang Seng Index and Nigeria’s market is proportionately under-developed through the time period.

What this shows is that if trade falls back, there is a strong likelihood that Emerging Market equities will also fall. Consequently, this will reduce the amount of capital flows into these economies. Again, the net effect is to dampen economic strength but, equally, potentially to create a self-fulfilling prophecy: trade effects feed lower capital flows which in turn lead to a decline in trade because of a lower capital base.

 

So what does the Fed do?

The Fed should not raise interest rates unless it is prepared to write off the emerging market debt that is denominated in US dollars. Monetary policy has become international as well as national and it may well be that the United States’ long-term interests are not served by a strong US dollar. Emerging Market trade, oil prices and the value of Emerging Market currencies, and over-valued EM equities may seem unorthodox reasons for keeping interest rates on hold. But in the long term, it is the US that will lose if the debts cannot be repaid.

Asset of the month: Crude numbers

Why oil prices may well be on the rise in March |  The Delta Economics asset price forecasting model is calling oil long this month reversing the extensive fall in oil prices. The Information Ratio, which measures the performance of our index each month against benchmark returns, is at 0.79 for March’s oil call. Any Information Ratio value above 0.5 suggests strong back-tested performance.

There are two reasons for being bullish about oil. First, March of any year usually sees a seasonal pick-up in trade following Chinese New Year. Trade and oil prices are highly correlated (0.94) and move in the same direction: if oil prices rise, then trade usually rises too. This usually reflects an increase in demand for that month (Figure 1).

 

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Figure 1  |  Monthly value of world trade (USDbn) versus WTI Oil, Last Price Monthly, June 2001-December 2015 (forecast)
Source  |  DeltaMetrics 2015, Bloomberg

 

Second, Saudi Arabia has increased crude oil prices for April’s sales to Asia. This is bound to put upward pressure on prices in March more generally. Not least because it hints that Asia’s economy may well be turning a corner. The correlation between Chinese trade and oil prices is very high at 0.89. Chinese trade similarly dips at the beginning of the year but Delta Economics sees a rapid pick-up during March with overall growth in Chinese trade for 2015 looking positive at over 7%.

 

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Figure 2  |  Monthly Value of Chinese trade (USDbn) versus WTI oil Last Price Monthly, June 2001-December 2015 (forecast)
Source  |  DeltaMetrics 2015, Bloomberg

 

The pick-up in demand at the end of Q1 is quite marked. The forecast for oil during 2015 is for a rise in oil prices alongside a modest increase in the rate at which world trade is growing – from 1.2% in 2014 to 1.9% in 2015. However, this does not herald a return during the year to values above $100 a barrel. The modest growth in trade we are forecasting for the year is substantially slower than the post-2008 oil price trough and, as this suggests that global demand remains slack, the crude numbers do not suggest rapid increases in oil prices during the year.

 

Asset of the month: Crude numbers  |  Author  |  Rebecca Harding  |  CEO

China’s nerves of steel

Why January’s drop in exports may not be such bad news |  Chinese exports in January 2015 fell by 3.3% compared to a year earlier. Its imports fell by over 19%. Analysts had expected exports to grow by over 6% and the slowdown in imports to be less marked than it was. The Hang Seng Index (HSI), which has a high correlation with Chinese exports, dipped slightly on the news but had rallied by the end of the week.

Delta Economics views this rally as temporary: seasonal volatility in Chinese trade in January and February coupled with lower commodity prices means that we are likely to see a further drop in the value of China’s exports in February. Although the trend during the course of the year for the HSI is positive, lower trade could impact substantially on the value of the HSI until the end of Q1 2015 (Figure 1).

 

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Figure 1  |  Monthly value of Chinese exports (USDbn) vs Hang Seng Index, LPM, June 2001-Dec 2015 (forecast)
Source  |  Delta Economics, Bloomberg

 

Of particular concern to analysts was the drop in imports in January. China’s trade is 83% correlated with oil prices and therefore the recent drop in oil prices goes some way to explaining the fall. Further, a more general drop in commodity prices would also have impacted on China’s import trade values for January: China’s trade is 61% correlated with steel prices for example. Given that we expect an increase of 5.8% in iron and steel trade in 2015, compared to 2.4% in 2014, it would be reasonable to conclude that seasonal effects and falling commodity prices are more likely to be responsible for January’s, and potentially February’s, drop in trade values rather than a drop in demand.

Iron and Steel trade is a good proxy for infrastructure development and economic growth within China. China is a net importer of Iron and Steel, the largest products within which are flat rolled alloy steel and hot rolled steel products. China’s exports predominantly go to emerging markets in Asia while China’s imports come from South Korea, Japan, Europe and the United States. China has a net trade deficit in iron and steel, yet to its key export partners, its market penetration is above average for the world.

 

2015-02-16_nervesOfSteel_fig02

 

Figure 2  |  Rebalancing of Iron and Steel trade
Source  |  Delta Economics, Bloomberg

 

The clearest indication of a reorientation of Chinese policy away from export and infrastructure-led growth in favour of demand-led growth can be found in its reimports of iron and steel. These are products that originate in China but are exported and then reimported from Chinese territories or Special Administrative Regions (such as Hong Kong, Macao or Taiwan). Over the past two years reimports have been slowing which suggests that China is utilising its internal resources less – arguably reducing its stockpiles.

Chinese trade, and particularly its iron and steel trade, matters for the rest of the world. But its importance is not as a proxy for the health of the Chinese economy. Instead, it matters because markets perceive it as a bellwether for the health of the Asian economy. For example, the HSI is 81% correlated with Chinese trade and 89% with the KOSPI. Similarly the Australian dollar’s correlation with Chinese iron and steel trade is 82%. While these do not reflect causality they do suggest that regional market sentiment and trade are strongly associated.

 

2015-02-16_nervesOfSteel_fig03

 

Figure 3  |  Monthly value of iron and steel trade (USDm) versus USD-CNY spot, Last Price Monthly
Source  |  Delta Economics, Bloomberg

 

Weaker trade data in the first part of 2015 is likely to result in a depreciation of the yuan (Figure 3). In recent months there has been a slight revaluation of the yuan but we see it depreciating further over the next two quarters as trade growth remains sluggish after it spikes in March. The correlation is negative at -82%: in other words, a currency depreciation will have a positive impact on iron and steel trade, because the currency elasticity of commodities is high.

This will have broader consequences for the rest of the world, not least by potentially aggravating trade relations between the USA and China by making US imports into China more expensive. It would also make European imports into China more expensive and, at a time when the European economy is looking to re-establish its growth, the importance of the Chinese market cannot be understated.

Once again this demonstrates the power that China has to manipulate its own performance and therefore to impact the economies of the rest of the world. Emerging markets equities are likely to react negatively to slower Chinese trade in the short term while the Australian dollar may well become weaker against the US dollar because it is so influenced by the performance of the Chinese economy generally and trade in particular.

If the yuan devalues further, this also has the potential to threaten any export-led growth that may be developing in Europe and the export-fuelled growth that the US is enjoying. The broader geopolitical risks of embarking on a currency war to protect China’s domestic interests as it restructures would stall trade negotiations at the very least. The hope is there will be no devaluation as China seeks to restructure its economy. The outlook for trade towards the end of 2015 and into 2016 for China is certainly brighter, but to get through the first quarter at least of 2015 markets and analysts will need to have nerves of steel.

Dragons and Eagles and Bears, oh my! Geopolitics among global powers

Dragons and Eagles and Bears, oh my! Geopolitics among global powers in 2015  |  Tensions between the world’s major powers are expected to continue in 2015 but are unlikely to develop beyond sabre-rattling. At this stage, we expect potential crises (for example, in the South China Seas in Asia and Moldova and Ukraine in Europe) to have greater regional, rather than global, significance. However, oil prices are a potential flashpoint with global repercussions.

A recent report released by the Eurasia Group wrote that 2015 will herald the return of geopolitics; in reality, geopolitics never went away. At Delta Economics we identify trends and patterns in world trade so the implications of political events for markets have long been evident in our forecasts. Indeed, in the run-up to a geopolitical crisis we often see a noticeable impact on trade.

For example, analysis of the historical trade data in the years before the 2008 Georgia conflict shows an unprecedented increase in Russian trade with Georgia (Figure 1). Interestingly, this increase began almost immediately after Putin’s State of the Nation Address during which he declared that ‘the collapse of the Soviet Union was the greatest geopolitical catastrophe of the century’.

 

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Figure 1  | Russia-Georgia Total Trade, 2001-2008
Source | DeltaMetrics 2015

 

In fact, trade may even anticipate social and political upheaval in a timely manner. For example, in the months preceding the revolution in Ukraine last year we noted a substantial year-on-year spike in Ukraine’s imports of riot gear and ammunition from Russia at 20.1% and 13.6%, respectively. This was compared with just 1.8% growth in Ukraine’s imports generally.

So what do we think will happen in 2015? Relations between the major global powers have not been this strained for decades and China, Russia and the US are likely to continue to dominate the headlines. Our trade data reflects this suggesting ever-strengthening trade patterns on clearly delineated East-West lines: for example, Russia’s trade is set to spike in 2015 according to our latest estimates prompted by at 14.5% increase in trade with China and an 8.8% increase in trade with Iran. This compares with growth in trade with the US which we expect to fall from nearly 12% growth in 2014 to 4% growth in 2015.

 

In spite of a weakening economy, Russia is still a threat to European stability |  The crisis in Ukraine has not been resolved. Russia is certain to continue to support separatists in the Donbas, while the West is also likely to keep sanctions in place. This will leave the Ukrainian economy in precarious position. We expect Ukrainian exports to continue to suffer, contracting from 0.5% in 2014 to -0.2% in 2015.

Another region to keep an eye on in 2015 is Moldova. The country is politically significant to both the EU and Russia. It has been a “frozen conflict” since violence broke out in the breakaway region of Transnistria in 1992. Russia responded by stationing a small number of troops and a large arms stockpile. Russia also continues to offer the region substantial financial support.

However, an election in late 2014 saw Moldova deepen ties with Europe, with pro-European voters gaining 45.5% of the vote. This unlikely to sit well with Russia or the 370,000 ethnic Russians of Transnistria who accused Moldova of rigging the vote. Figure 2 shows that we expect a substantial increase in both imports and exports to Moldova to 2017. Worryingly, the trade pattern seems to reflect the spike in trade seen before the Georgia Conflict (Figure 1).

 

2015-01-21_CommentsAnalysis_010_geoRisk2015_fig02

Figure 2  | Russia-Moldova Total Trade, 2013-2017
Source | DeltaMetrics 2015

 

We expect China to continue to challenge US hegemony, but tensions may flare with neighbours in the South China Seas  |  Our forecasts show a return to healthy levels of import and export growth at 8.9% and 7.2%, respectively. This growth is largely a result of Xi Jinping’s political reforms: there has been a formal recalibration of China’s economic priorities away from traditional export-led growth towards greater domestic consumption. While crackdowns on corruption will reduce factional power struggles and ensure party policy is more consistent – crucially in the area of foreign and security policy.

However, Xi’s pivot away from the notion of individual prosperity towards a collective sense of Chinese greatness has been characterised by growing economic and political nationalism. This manifests itself in regular military posturing – particularly in the South China Seas. Some regional powers see China’s behaviour, specifically the construction of factories across the Nine-Dash line, as an attempt at a land grab. Last year Vietnamese and Chinese vessels came to blows and there is an ongoing arbitration dispute with the Philippines. Sino-Japanese relations are also strained over the Senkaku/Diaoyu island dispute. There will be no easy solution to these problem and we expect it to rumble on throughout 2015.

The biggest risk to China is perhaps that it is alienating itself in the region and therefore inadvertently aiding their main rival: the US. At Delta we are already seeing evidence of this trend in our forecasts with rates of US total trade growth to the Asia Pacific region set to jump from 2.7% in 2014 to 4.2% in 2015.

 

Russia and China may emerge as strong economic partners  |  It is unlikely that China will curb its military spending or industrial production in the near future. Chinese demand for energy is huge in China and, after the Ukraine crisis, it appears China has found a key partner to meet its burgeoning demand for oil.

We expect a significant increase in trade between the two nations. Bilateral trade growth was a paltry 0.7% in 2013 but 9% in 2014; this is clearly indicative of a booming relationship. This has been epitomised by recent deals such as the Gazprom-CNPC contract which is worth an estimated $400 billion. As well as the recent Vankor pipeline deal, referred to by Putin as “the biggest construction project in the world”. The Vankor oil project is estimated to be completed in 2019; a sign of Russia’s long-term commitment to trade with China.

So, although 2015 is unlikely to see any catastrophic bust-ups between the world’s major powers, tensions are certainly simmering. If there is one factor which has the potential to be the proverbial “straw that breaks the camel’s back” it is oil. Russia is also deepening ties with oil-producing Latin American countries. Russia, of course, has little need of oil itself and is clearly attempting to undermine US interests. Oil trade may well turn out to be a metaphorical battleground as the year progresses.

 

Dragons and Eagles and Bears, oh my! Geopolitics among global powers  |  Author  |  Jack Harding  |  Analyst and Publications Manager

Pour Oil on Troubled Waters

There is no reason to think the oil prices will not go down further given the current state of affairs. We are entering unchartered territory and, looking at our estimates, it is very likely that the price of crude will bottom out at $40. Indeed, most commentators point squarely at supply (or over supply) rather than demand deficiency as a main driver for the spiralling prices.

Whilst the US remains the largest producer (and consumer) of crude, in terms of international trade, Saudi Arabia was the largest exporter of crude in 2014 and is forecast to reign at the top spot in 2015. Delta Economics forecasts world crude exports to take a hit in 2015 with a -1.28% reduction in exports on the previous year (2014). As global demand continues to dampen because of weak economic activity, oil exporters such as Saudi Arabia are responding by slashing prices to the EU and US yet increasing them to Asia. This is understandable given the inelastic nature of crude. Indeed it seems Saudi Arabia is more willing (and able) to absorb potential losses because it accumulated a generous buffer when prices were high. Qatar and Kuwait, too, are better poised than producers such as Venezuela, Iran and Russia, all of whom are experiencing budgetary strains – some small (Russia), some large (Iran), with one, Venezuela, facing imminent default unless China, the largest crude importer, steps in to negotiate some kind of agreement. OPEC nations agreed last month to maintain production at their usual level, whilst non-OPEC producing nations have stoked up their capabilities, which helps drive down the price of crude even further.

The Shale Revolution on the other hand is helping the US wean itself off its dependency on international crude. However, as reports have shown, the extraction of Shale is only viable if oil prices remain high: lower prices are only adding pressure to Shale producers’ business model. But let’s not forget that lower oil prices are also great news for the largest importers of oil such as US, India, China and the EU, all of whom are experiencing an unintended windfall that is likely to be passed on to the consumer in the months to come.

 

 2015-01-19_CommentsAnalysis_009_fig01


Figure 1
 |  Pour Oil on Troubled Waters
Source  |  DeltaMetrics 2015

 

Pour Oil on Troubled Waters  |  Author  |  Shefali Enaker  |  Economist