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CS: Capacity cuts boost China’s commodity sector

Commodity prices have rebounded since the start of the year and A-share commodity stocks are expected to outperform in the third quarter, Credit Suisse said.

Coal, steel, copper and aluminum prices have increased by 12%, 36%, 12% and 17%, respectively, since the end of 2015.

“We believe this rebound will continue due to the ongoing supply-side reform and expansionary monetary policy globally and within China.”

The rising prices are linked to the decline in production and capacity of major commodities. For example, coal production has fallen by 12% year-to-date, while 16 major provinces have provided detailed plans for capacity cuts since the beginning of the year, the bank said.

“We expect more supply-side reform details to be announced before the year end.”

The bank said that the A-share commodity stocks are performance laggards compared to other global peers, even worse than their Hong Kong counterparts (H-shares).

“We believe they will catch up in the third quarter, supported by earnings recovery. Market consensus has been gradually revising up [their] 2016 EPS forecasts.”

Coal and steel stocks are preferred among commodities based on their valuations, recent performance and earnings revisions. “We add Angang Steel into our portfolio.”

Bull replacing bear?

From a global perspective, Schroders said in late May that it believes that the majority of commodiites have bottomed, heralding the start of a new bull market.

“Following five years of devastatingly poor returns, sentiment toward commodities is at rock bottom, but it’s starting to turn following the surge in the prices of a wide variety of products since the beginning of the year,” said Geoff Blanning, head of commodities at Schroders.

There are a number of supportive factors at play, he said.

First, many commodities fell in price as a result of overproduction following the previous price boom, made worse by the availability of cheap credit. “The situation is quite different today – for example, in the oil market, where many US producers are going bankrupt. With prices down 70-80% in many commodities, production is no longer growing.”

Second, the dollar bull market from 2011 to 2015 was a major contributor to weak commodity prices, he added. “But this year, the dynamic has started to reverse as the dollar has weakened.” 

Finally, despite this year’s rising commodity prices in China, Schroders believes the China-driven commodity boom may be over. But there is strongly-rising commodity demand from another emerging market: India, he said.

“India’s demand for crude oil, for instance, is currently growing at a much faster rate than that of China, which is making a big difference to oil market dynamics, and Indian demand for a whole range of commodities, including palm oil, sugar, rubber and natural gas, is rising fast.”

He said the biggest price gains, in percentage terms, occur at the beginning of a bull market.

“Now is the time for investors to focus on this unloved asset class.”

Part of the Mark Allen Group.