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OPINION

Why China's money matters

Why China's money matters
June 3, 2015
Why China's money matters

I say so because fluctuations in the growth rate of China's M1 money stock (notes and coins plus demand deposits) are closely linked with changes in commodity prices, as measured by the S&P GSCI. Slowdowns in Chinese M1 in 1997, 2001, 2008, 2012 and in 2013-14 were all accompanied by falling commodity prices. And rises in M1 growth in 2000, 2003, 2007 and 2010 all saw commodities rise. There's a slight tendency for falls in M1 growth to be a leading indicator of falls in commodity prices.

There's a simple reason for this. If companies are planning to increase output, they need to raise cash to buy supplies; the upshot is that M1 rises just before production does. And as production rises, so does demand for raw materials - with the result that commodity prices rise. And if firms plan on scaling back output, the opposite happens.

Herein lies some bad news for anyone hoping for a sharp turnaround in commodity prices. Latest figures show that Chinese M1 grew by just 3.7 per cent in the year to April, close to the slowest rate on record. This does not point to rising commodity prices, which should worry those exposed to commodity stocks.

However, there might be two comforts for such investors.

First, Simon Ward at Henderson points out that China's measure of the M1 money stock, unusually, includes only the bank deposits of companies, and not households; this matters, given that the government wants to shift the economy towards more consumer-led growth. He estimates that if households' bank deposits are included, there are tentative signs of an acceleration in monetary growth. This, he says, "should be reflected in a recovery in economic growth over the summer/autumn".

Secondly, the fall in commodity prices over the last 12 months does not look unusual, given the slowdown in Chinese M1. This suggests that the fall is due mostly to weaker demand rather than to any permanent increase in supply. And this in turn suggests that the drop is cyclical rather than permanent. This implies that if or when Chinese demand does revive, so too should commodity prices with, probably, favourable effects for mining stocks. Unless you believe that all of China's slowdown is a permanent shift to a slower growth rate, there might therefore be reasons for holders of commodity stocks to be a little optimistic.