Commodities may be first to show trade war impact

The phoney war stage of US President Donald Trump’s trade dispute with China may be ending, with economic indicators and commodity flows and prices starting to show real world effects. The latest signal that China’s economy may be feeling some pain associated with Trump’s tariffs on about $34 billion (Dh124.87 billion) in Chinese goods was the softening of the Purchasing Managers’ Index (PMI) in July.

While the overall drop to 50.8 in July from June’s 51.0 was small, of bigger concern was the slump in the subindex for new export orders, which dropped to 48.4, a fourth consecutive monthly decline.

The drop in the PMI, a key indicator of manufacturing health in the world’s second-largest economy, came as Trump’s administration proposed a 25 per cent tariff on another $200 billion in Chinese goods, up from an earlier 10 per cent plan.

US Trade Representative Robert Lighthizer said in a statement on Wednesday that Trump directed the increase from the previously proposed duty because China has refused to meet US demands and imposed retaliatory tariffs on US goods.

While a poor PMI for one month doesn’t necessarily signal a new trend, it does highlight the risk that the trade dispute is starting to hit economic growth.

The so called Phoney War was an eight-month period of limited engagements and conflict at the start of the Second World War.

While a trade dispute is obviously not comparable to a shooting war, the current USChina imbroglio may follow a similar pattern of months of mainly rhetoric and skirmishes before an eruption into a serious economic event.

As early indicators of global economic health and trade flows, movements in commodity prices and volumes can be instructive.

The temptation is always to look first at copper, given its correlation with both manufacturing and construction. London Metal Exchange copper futures have been trending lower since reaching their peak for this year so far in early June, closing at $6,172 a tonne on Wednesday.

This is down almost 16 per cent from the June peak, a period that coincides with the ramping up of tariffs by the United States, coupled with increasingly bellicose rhetoric.

China’s appetite for imported copper has yet to falter, however, with first-half imports of unwrought copper up 16.3 per cent from a year ago, according to Chinese customs data.

In fact, the rate of growth in the first half well exceeded the 3.6 per cent increase in imports of copper in the first half of 2017, showing that not only is China importing more of the industrial metal, it’s doing so at a faster pace.

The strong copper imports may seem contradictory to the weak prices, although it’s likely that the market has been dropping mainly on sentiment, rather than on supply and demand.

Other commodities also paint a mixed picture, with China’s iron ore imports dropping 1.6 per cent in the first six months of 2018 from the same period last year.

Iron ore prices have also been dropping, with benchmark 62 per cent fines, as assessed by Argus Media, ending at $66.50 a tonne on Wednesday, down almost 17 per cent from their peak this year of $79.90 in late February.

Conflicting signals

The steel sector appears robust, though, with prices rising and solid gains in China’s steel PMI, to a seven-month high of 54.8 in July, well above the 50 level that demarcates expansion from contraction. Fundamental reasons can be found for both the weakness in iron ore, which is well supplied, and the strength in steel, which is still seeing strong demand and pollution-related output restrictions.

Coal is another commodity that appears to have been unaffected by trade war concerns, with both Chinese import demand and prices rising strongly. China imported almost 10 per cent more of the polluting fuel in the first half of 2018, while the benchmark thermal coal price at Australia’s Newcastle port rose to $121.75 a tonne on Wednesday, the highest in 6-1/2 years. China’s coal demand for power generation has been rising and domestic output gains haven’t been able to keep pace, meaning a draw on the seaborne market, which is already supply constrained, with major exporters Australia and Indonesia unable to boost output.

There are commodities that have been affected by the trade dispute, but not to the extent of influencing global pricing, at least so far. China appears to have stripped back its imports of US crude oil to near zero for September, having taken about 333,000 barrels per day in the first six months of the year, according to vessel-tracking data. It’s the same story for liquefied natural gas (LNG), with only one US cargo booked for arrival in August, and it departed the Gulf of Mexico on July 1, before much of the current escalation in the trade dispute.

The odd thing is that crude oil and LNG aren’t subject to any formal trade tariffs, and they appear most affected, while steel, which is the target of US tariffs, is performing strongly.

Logic suggests that if the trade dispute does continue to drag on China’s economic performance, eventually steel will join copper in trending lower.

Thus, keeping an eye on China’s imports of major commodities in coming months will be key to working out just how quickly the trade dispute is filtering through to the real economy, and determining if the phoney trade war has become a real one.