China's growth forecast chills commodity markets

The prospect of slower growth in China threw a scare into commodity markets on Monday, raising worries about the sustainability of Asia's voracious demand for a host of natural resources.

Commodity prices slumped and stocks in the sector retreated sharply after China lowered its gross domestic product growth target for the year to 7.5 per cent from 8, extending a trend of slowing expansion. Last year the economy grew by 9.2 per cent, down from 10.3 in 2010.

The new GDP target, if hit, would be the first dip below 8 per cent since 2004, a significant change for the world's second-largest economy. China is a huge buyer of raw materials – its demand takes up more than 40 per cent of the world's copper, zinc, aluminum and nickel – so any slowdown in consumption can send prices tumbling in those commodities and many others.

The S&P/TSX capped metals and mining index sank 4.4 per cent Monday. Copper prices fell about 1 per cent, while gold was down $5.90 (U.S.) an ounce to $1,703.90.

Bart Melek, head of commodities strategy at TD Securities, said markets have been "almost euphoric" in the past few months, and the reality is sinking in that Chinese growth is slowing. Still, the Chinese government had already signalled a slowdown, he noted, and the pullback may prove short-lived.

On the floor of the Prospectors and Developers Association of Canada convention in Toronto on Monday, miners were focused on the nuts and bolts of their businesses, expecting that China will continue to underpin solid long-term demand for metals.

Clynt Nauman, chief executive officer of silver, lead and zinc miner Alexco Resource Corp., said China's slower growth may prompt some price declines, but not a collapse. "It's high-growth rather than unbelievably spectacular growth," he said. "I don't think it'll have a big impact on our business."

Labrador Iron Mines Holdings Ltd. vice-chairman Bill Hooley said that last year, his firm sold all of its production to China. Still, he said, "China slowing down doesn't necessarily mean the iron ore price collapses, though demand may weaken."

Patricia Mohr, commodity market specialist at Bank of Nova Scotia, said Chinese growth performance is exceptionally important because "China is highly dominant in most raw materials markets around the world."

Ms. Mohr and other commodity experts say they expect the price softness to be temporary, with strength in the sector to resume within months thanks to broad growth in Asia, an improving U.S. economy, and a slightly improved picture in Europe.

"I think the bull run in commodities, based on emerging market growth, is still going to be with us for the next five years at least," Ms. Mohr said. She expects a "soft landing" in China's economy with "reasonably strong" economic growth this year and next. Consequently, metals and mineral prices are going to avoid a severe drop, she said, "and in fact probably rally back as we move through the year."

In addition, TD's Mr. Melek said, it is highly likely that Chinese officials will take some steps to stimulate the weakening economy. These actions could range from cutting interest rates to direct stimulus – such as beefing up an already massive program to build more affordable housing. Those actions could help lift commodity markets worldwide, he said.

Because the commodity-price impact from a weakened Chinese economy will be relatively brief, it is unlikely there will be much in the way of structural changes at Canadian commodity producers, Mr. Melek said. Projects now under way are likely to be unaffected.

Even if copper, gold or silver were hit by significant price drops, they are still high enough that mining companies will continue their expansion, he said. "In copper, even a 20 per cent dip [in price]would mean that most producers are still making a lot of money."

One commodity that may not see much impact from a weaker Chinese economy is oil.

Slower growth in China will certainly push down demand growth for oil, said TD Securities' energy commodity strategist David Bouckhout. In theory this would put downward pressure on prices, but that effect is being offset at the moment by the "geopolitical risk" in Iran, which is driving prices in the other direction.

If there is some military action in Iran, oil prices will spike, Mr. Bouckhout said, because of disruptions to oil flowing through the Strait of Hormuz. The impact of China's slightly weaker economy would be completely masked in that situation, he said.

On Monday, the price of oil rose 2 cents to $106.72 a barrel.