Commodity Prices Retreat on Weak Chinese Manufacturing Data

Manufacturing activity in China contracted for the third month in a row in October. Asian stocks, oil, gold and other commodities pulled back this week as investors weighed the new data which suggests that China’s slowdown may be deeper than previously thought. The official manufacturing manager’s index came in at 49.8 points for the month. Since it is below 50 we know that it indicates the sector is shrinking. But it’s also important to point out that this is the same number that was released for the previous month of September. So this could mean that china is headed towards some kind of stabilization.

Slow Growth is still Growth

I think the trend we’re seeing here means that China’s economy is slowing down, but it’s not collapsing like a lot of people thought over the summer. We’re seeing a contraction in the Chinese manufacturing data. But at the same time there is modest growth in the services sector. The real problem however, is we don’t have the clear data to show what China’s economy is really growing at. The way that the Chinese government reports GDP numbers and economic growth is not the same process as is used by the United States and other western countries. A lot of the information we’re currently receiving out of China are quite doctored by the central government. In a lot of cases we don’t even know the methodology that’s used to obtain the data. For example sometimes the numbers use one month’s worth of data, while other times it could use six week’s worth of data.

We don’t know exactly how the government in China will address the recent economic slowdown in the country but we do know they are supportive of continuing growth and opting towards stimulus when necessary. Li Keqiang, China’s head of government as well as one of the leading figures behind Chinese economic policy, has affirmed that it wants to grow the country’s GDP to $12 trillion by the year 2020. That means China’s economy will have to average a minimum of 6.5% growth over the next five years to reach this lofty goal, which would be a slower pace than the roughly 7% expansion published so far this year.

I don’t think China should be in the business of targeting a specific growth rate such as 6.5% or 7%. It is very difficult to predict an exact figure like this. Estimating a range of possibilities would be a much better policy for them. Targeting a growth rate leaves them open to the risk of losing credibility if they get it wrong. But if they target a range of 5% to 7%, for example, then that will give them more flexibility when reporting the numbers.

Having a commitment from the Chinese government to support the growth of the economy at 6.5% is good news for commodity investors around the world. But it may not matter because the real growth in China may not line up with the posted numbers. If the economy actually grows 4% but the reported number from the Chinese government is inflated to 6.5% then that doesn’t give investors a very clear indication of near term demand of resources. So the best course of action for investors right now is to hold onto any resource stocks or bonds. The demand for production in China may have stalled, but the economy on a whole is still growing.

The falling prices of oil, base metals, and other hard commodities in recent times is partly due to the uncertain economic numbers coming out of the second largest economy in the world. A couple of years ago it became convenient for average Chinese citizens to trade stocks on their own. Last week the Communist Party announced it will abandon the one-child policy, putting an end to a 30+ year law that prevents parents from having more than one child. As gradual economic and social reform continues to take place in China, I’m hopeful that its government will become more transparent in its economic reports.

Photo Source