By John Richardson
WE hate to say we told you so but the 15 per cent fall in oil prices last week – the steepest one-week decline in two-and-a-half years - was evidence of growing concern over the health of the global economy.
And as we predicted on 12 April, last week saw a broad sell-off of commodities in general.
Polyethylene (PE) prices in China were understandably down by $10-20/tonne, according to last Friday’s assessment by our colleagues at ICIS pricing.
Price retreats were recorded across a broad range of chemicals and polymers, including a further $50/tonne fall in purified terephthalic acid (PTA), again according to ICIS pricing.
The fibre intermediate is now down by 11 per cent over a three-week period – a perfect example of how pricing has been driven-up by surging crude costs and is now on the retreat.
The run-up in crude and commodities in general has in our view been disproportionate to the underlying strength of the recovery. More expensive oil has been largely the result of the “one-way bet” on the Fed maintaining record-low interest rates for a long time to come.
The end of QE2 seems to have been a factor behind the rout in commodity prices last week.
But the biggest reason, we feel, is that investors suddenly realised, as the negative economic news built, that they were over-exposed on commodities and headed for the hills. A solid indication of this retreat was strengthening of the US dollar.
Despite good US job growth – the data for which was released on Friday - the US economy faces major problems, most importantly how to solve the budget deficit with Democrats and Republicans miles apart.
Sovereign debt issues in Europe could still create an global economic shock comparable to that, or perhaps even worse, than the collapse of Lehman Bros.
And, of course, there is China where most of the blog’s attention has been focused over the last few weeks.
China confronts rising inflation, which has:
1.) Restricted the ability of chemicals and polymers producers to pass-on cost increases down value chains to finished goods
2.) Weakened the competitiveness of Chinese exports as a result of higher raw-material and labour costs
3.) Raised the prospect of major social unrest as a result of asset-price inflation that has widened the gap between the super-rich – those who made a fortune from China’s huge late 2008 economic stimulus – and the average worker
4.) Left the government trapped between the devil and the deep blue sea. It might end up overreacting through too-stringent steps to contain inflation, or it may fail to take sufficient measures to reign-in rising costs, resulting in more of the social pressures we have just referred to
Last week’s slump in commodity prices, if sustained, might make the job of tackling inflation in China – and other Asian countries such as India, which raised interest rates last week - a lot easier.
But the reasons why commodity prices declined should be of major concern for chemicals companies – particularly those that have presented a rather rosy view of China’s immediate future and. Such companies may not, as a result, be prepared for the worst.
As we said, the global recovery is on very shaky ground. Support for this view is provided by recent surveys of purchasing managers working for Asian manufacturers. The resulting indices show that while orders have been growing, so have inventories, suggesting a slowdown in exports to the West.
This should be a big concern for the chemicals industry as we approach the peak manufacturing season in China, which runs from around July-August to September.
The peak season occurs as manufacturers of finished goods increase production in order to get finished goods on the shelves of Western retailers in time for Christmas.
A decline in imports of chemicals and polymers during this period – which are re-exported as finished products – would provide further support for our arguments.
Any declines could, though, be also the result of a low-end manufacturing having drifted to other emerging economies with lower labour costs – and so a wider examination of trade data might be necessary.