It All Begins And Ends With China: "Is The Global Reflation Cycle Ending?"

Submitted by Gordon Johnson of Vertical Research Group

FIRST… THE “HARD DATA”.

Last night, China released factory inflation numbers (i.e., PPI), which slowed for a fifth straight month in Mar. ’18… marking the slowest Y/Y growth rate since Oct. ’16 (Exhibit 1). Similarly, the Mar. ’18 consumer price index (“CPI”) retreated from the four-year high set in Feb. ’18 (Exhibit 1).

Interestingly, we note that the Mar. ‘18  +2.1% Y/Y growth in China’s PPI missed Consensus’ expectation of +2.6% Y/Y growth, while the Mar. ’18 +3.1% Y/Y growth in China’s PPI also missed Consensus’ forecast of +3.3% Y/Y growth.

Exhibit 1: China’s Inflation Gauge – CPI vs. PPI Indexes

Source: National Bureau of Statistics, Vertical Group.

WHAT’S DRIVING COMMODITY-PRICE DEFLATION IN CHINA? As we’ve argued before, and as noted in Exhibit 2 below, it appears the swift collapse in China’s credit impulse (i.e., a fancy way of saying China is issuing less debt as a % of GDP) is driving a correction in China’s commodity consumption. Why does this matter? Well,  in our view, steel price strength in 2017 was due to China’s steel exports falling 33.4Mmt, or the second largest decline ever, trailing only that seen in 2009 (Exhibit 5) – China produces roughly half of world’s steel, meaning when they export less, global prices rally. While the driver in 2009 was the global financial crisis (“GFC”), the driver in 2017 was a record credit stimulus in China (i.e., $4.9tn in new credit issued) driving domestic demand, and thus boosting domestic Chinese steel prices. So, in general, while in most years China’s steel prices lag the rest of the world, in 2017 they were much higher; this, in turn, pushed mills in China to ship more domestically vs. to other countries, and thus drove up global steel prices –given China was >50% of global steel production in 2017, this had a big impact on global steel prices. However, this dynamic is now in reverse (Exhibit 6), which we believe forebodes risk to global steel prices.

Exhibit 2: China's Credit Impulse Y/Y% vs. Metals Commodity Index

Note: Credit impulse = (total social financing [net of non-financial equity] + local government debt issuance) ÷ nominal GDP; all metrics are trailing 12-month. Source: People's Bank of China, National Bureau of Statistics, Bloomberg, Vertical Group.

Furthermore, as it relates to the “synchronous recovery” meme, after falling in both Jan. ’18 and Feb. ’18, the JPM Global PMI plunged  by -0.7% Y/Y in Mar. ’18, dropping by the most in any single month since 1Q16’s global growth scare (Exhibit 3). While, admittedly, some of the weakness in Mar. ‘18’s global growth could prove temporary, with such a broad-based weakening across a number of countries, we surmise that global growth has indeed peaked (this is not Consensus).

Exhibit 3: JPM Global PMI - 5 month low in Mar. '18

Source: JPM, Bloomberg Vertical Group.

CONCLUSION. When analyzing China’s Mar. ’18 PPI internals, looking to see what drove such weakness in China’s factory inflation numbers (Exhibit 7), it becomes clear that price deflation across the raw material and basic industrial complex was among the key drivers. Consequently, given China’s PPI is an excellent leading indicator into how China’s industrial economy is fairing, and also considering China’s Mar. ’18 Caixin Manufacturing PMI missed Consensus’ estimate (i.e., 51.0 vs. Consensus’ 51.7), we believe the 2018 “China slowdown” meme is firmly intact (we remind our readers that China consumes the bulk of the worlds commodity-metal output). Consequently, while China’s Mar. ’18 excavator sales growth rate of +78.9% Y/Y got a lot of people excited this weekend (we received a number of inbound emails asking our opinion on this surprisingly strong number), China’s loader sales fell -50.3% Y/Y in Mar. ’18 (i.e., the weakest growth in any single month since 4Q15’s global growth scare) and China’s Mar. ’18 crane sales growth fell to -12.8% Y/Y, or the weakest rate of growth in 17 months.

As such, while China’s Mar. ’18 excavator sales numbers were admittedly strong, as displayed in Exhibit  4 below, given virtually all the prior spikes (and collapses) in excavator + crane + loader sales happened in unison, we feel the Mar. ’18 excavator strength is likely the outlier given acute weakness in both China’s crane and loader Mar. ’18 segment sales.

On the back of this data we would be adding to metals/mining and industrial shorts. The reason is simple… i.e., a growing slowdown in China’s industrial economy is likely to push commodity prices lower through 2018 (the data continues to support this view). Caveat emptor.

Exhibit 4: China Construction Vehicle Sales - %Y/Y

Source: Hong Kong Teng Yuan Co. Ltd., Vertical Group.

Exhibit 5: Chinese Steel Exports

Source: China customs general administration, Vertical Group.


Exhibit 6: Chinese Steel Prices – Rebar, HRC, and Billet

Source: China customs general administration, Vertical Group.

Exhibit 7: China Mar. ’18 PPI Internals

Comments

AnngeloJamaica saldulilem Thu, 04/12/2018 - 00:05 Permalink

It All Begins And Ends With China: "Is The Global Reflation Cycle Ending?"

Never heard so much bullshit in all of my life.  You must be speaking of part of the system that you belong to, In my world I am responsible for my own well being. It is called being independent and out of the system, so actually are are reliant on the system and full of bullshit.

You are a dependent on debt.  You have no clue what it means to be free and a sovereign. Hello slave.

In reply to by saldulilem

LetThemEatRand Wed, 04/11/2018 - 20:52 Permalink

It is appropriate that Trump began his campaign giving tours of his helicopter.  The bankers want inflation in all things but so far they've only succeeded in real estate (faltering) and stocks (faltering).   All indications are that Trump is working for the bankers, so I'd give it 12 months or less before the money starts raining down.

ldd LetThemEatRand Wed, 04/11/2018 - 22:34 Permalink

the only reason china went into massive debt and built like no tomorrow was to kick the can down the road. could it continue to do so? sure, why not. but it is obvious a decision has been made to either change direction or there has been a parting of ways. the next players can not take up the slack without a major fall. not too hard to imagine all these countries suddenly coming out of the cold was the continuation of this can kicking. for whatever reason we are now at a crossroads. hammer meet nail.

In reply to by LetThemEatRand

KimAsa Wed, 04/11/2018 - 20:58 Permalink

Chinese business - the private acquisition of a failing publicly traded company in order to circumvent the legal process of going public.  What do you get? Fraud on a massive scale- fill in the fake numbers.  That’s China in a nutshell. 

Grandad Grumps Wed, 04/11/2018 - 22:02 Permalink

A couple of more days here in China. I have been meeting with some mining/refining companies and customers.

It is now common for the larger companies to use their weight to issue commercial acceptance bills that may extend up to 6 months after the typical 90 day terms. I do not believe that this will end well ... and then what? Someone flush with cash comes in, buys up the most valuable assets for pennies on the dollar and the banks reset. Not good for the common folks, but the looting of cash has made a lot of people rich.

BTW, building continues on the interior of the country at a furious pace.