Is the party almost over for mining stocks? They’ve had a fantastic run, more than doubling since early 2016. But one indicator is warning of possible trouble ahead.
It’s that the growth in China’s money stock is slowing down. The annual increase in the M1 measure of the stock has slowed from over 25 per cent last year to 14 per cent now, and next week’s figures could show a further slowdown.
My chart shows why this matters. It shows that China’s M1 growth has been a leading indicator of changes in commodity prices, as measured by the S&P GSCI. Accelerations in monetary growth in 2006, 2009 and 2015 all led to commodity price booms a few months later, while slowdowns in 2007-08, 2011 and 2014 led to falls in commodity prices. There’s a simple reason for this. China’s monetary growth predicts the country's industrial production, which in turn is a big influence on demand for commodities and hence their prices.
The current slowdown in China’s M1 therefore warns us that commodity prices might be heading down soon. This matters for miners simply because falls in commodity prices are highly likely to be accompanied by falls in the FTSE mining sector – since January 2000 the correlation between annual changes in the two has been 0.63, which is a lot for volatile data.
Putting this another way, if we control for changes in the All-Share index then each percentage point of annual change in commodity prices has been associated with a 0.65 percentage point change in the FTSE mining sector. This might not sound much, but because commodities are so volatile they can do a lot of damage. A one standard deviation drop in them over 12 months, for example, cuts miners’ share prices by 17 per cent.
It’s not just miners that are vulnerable, though. The All-Share index generally is positively correlated with commodity prices, and not just because miners are a big part of the index.
Worse still, mining stocks tend to move in the same direction as emerging markets – for annual changes in sterling terms since 2000 the correlation has been a whopping 0.82. For example, emerging markets fell with miners in 2015, and have recovered with them since. The same Chinese slowdowns that hit commodity prices and mining stocks also depress growth and appetite for risk in emerging markets.
The slowdown in China’s monetary growth therefore warns us of possible double losses – on miners and emerging markets.
Now, there’s no case for immediate alarm. M1 growth is for now well above the rates that led to horrible losses in 2008 and 2015. What we have here is an amber warning light rather than a red one. And with miners and emerging markets both still above their 10-month moving averages, a good historic rule tells us there might be a little more juice to be squeezed out of them.
Nevertheless, investors in miners and emerging markets should at least consider their exit strategies, or at least ways of protecting themselves from possible losses. This is especially the case for those of you with big positions in both, as you are less diversified than you might think.
