Explained | What’s behind China’s attempt to rein in commodity prices?

The announcement sent ripples across metals and equities markets. Metal prices fell around the world from Australia to the US. Copper fell the lowest in seven weeks.

In India too, shares of metal companies slumped. Hindalco fell 2.7 percent, Tata Steel 2.8 percent, National Aluminium Co 2.6 percent, and Hindustan Zinc 1.8 percent. The BSE Metal index fell 2.58 percent, emerging as the top loser among the sectoral indices.

But the bulls fought back. Late evening on June 16, copper prices bounced back. Aluminium was largely flat.

Why is China worried?

China’s producer price index rose 9 percent in May, the highest in nearly 13 years. Rising prices of various industrial raw materials are making its products less competitive because companies are unable to pass on all the costs to consumers. Inflationary pressures pose a risk to economic growth in China. The Chinese Communist Party’s Global Times reported on April 12 that the country’s manufacturers were suffering because high input costs were squeezing their margins.

The report said home appliances are usually sold at a discount at this time of the year, but companies were forced to raise prices. “Companies can hike prices as their costs go up, but this trend cannot last for long. After all, the end price is subject to contracts and other factors, which cannot be changed quickly,” Hong Shibin, deputy executive director of the marketing committee of the China Household Electrical Appliances Association, told Global Times.

What other steps has China taken so far?

The Chinese government has repeatedly spoken against speculation and the steep rise in commodity prices. Last month, China said it would step up efforts to curb fast-rising commodity prices and prevent inflation, pledging more targeted measures to fight “abnormal trading” and “malicious speculation”, according to a report.

On May 9, China said it would take steps to strengthen the supply of commodities and asked coal producers to increase output. It also vowed to crack down on “malicious” trading and reinforce inspection of spot and futures markets, according to a report.

On May 24, Chinese regulators warned metals firms to maintain good market order. Chinese regulators pledged they would strengthen inspections of both futures and spot markets, while cracking down on irregularities and malicious speculation. Prices fell, and Global Times declared victory in a report saying: “Under the Chinese government's swift, resolute and concerted efforts to put down a sudden spike in steel prices, a bubble that began to suddenly inflate in early May started to deflate in recent days. While the bubble burst left many who rushed to the feast licking their wounds, industry insiders and analysts said it may take months for the steel market to return to normal.”

China also eased emission restrictions in the world’s largest steel-producing city of Tangshan in northern China, which calmed the market.

Will China succeed?

China is a major player in commodities. Thus, every statement and action from its authorities are keenly watched by markets around the world. When China was industrialising rapidly at the turn of the century, its demand for raw material triggered a commodities supercycle.

Still, experts say the country may not be able to take on market forces. Goldman Sachs believes that China does not have the muscle to change the price trend. It said prices were rising because of the demand-supply mismatch.

“The bullish commodity thesis is neither about Chinese speculators nor Chinese demand growth,” according to a Goldman Sachs report. “When commentators are unable to understand what is driving such a paradigm shift in prices, they attribute it to speculators - a common pattern throughout history, which has never solved fundamental tightness,” it said. Analysts say price dips may just be a buying opportunity.

Can sale of China’s strategic metal reserves help?

Given the lack of transparency about how much reserves its holds and how much would be sold over what period of time, experts and traders are unable to make an accurate forecast, but by all accounts, the country does not enough stocks to change the global outlook for commodities but it can certainly influence the sentiment.

Citi estimates that China has reserves of 2 million tonnes for copper, 800,000 tonnes for aluminum and 350,000 tonnes for zinc, based on past purchase and sales records. “Our base case is for total volumes of … aluminum and zinc selling to be around 2% of China’s annual demand, i.e. around 770,000 tonnes of aluminum and 140,000 tonnes of zinc, and for copper volumes to be minimal,” it said, according to a report. Experts say metals markets may have already priced in some sales from China’s reserves.