Chinese Economic Slowdown May Lead to 75% Plunge in Commodities, S&P Says

A “sudden” slowdown in China may lead commodity prices to fall as much as 75 percent from current levels, Standard & Poor’s said.

Unexpected shifts in government policies or problems in the banking sector may trigger such a slowdown, S&P said in a report e-mailed today. The floor for aluminum is 65 cents to 70 cents a pound ($1,433 to $1,543 a metric ton), compared with about $1.20 a pound now and copper’s floor is $1.50 to $1.75 a pound, compared with $4.10 a pound currently, S&P said.

“Given the extent to which China has bolstered commodity prices, that’s something that we have to be concerned about,” S&P analyst Scott Sprinzen said by telephone from New York. “The efforts by the government in China to slow growth are having an effect on commodity prices. It’s been a pretty modest correction so far.”

The Standard & Poor’s GSCI index of 24 commodities dropped 6.8 percent last month, the first decline since August, as accelerating inflation in China fanned speculation growth will slow. China’s central bank has raised benchmark interest rates four times and boosted lenders’ reserve-requirement ratios by three percentage points since September.

The central bank may raise rates ahead of a public holiday on June 6 because consumer prices are expected to rise to a new high in May, the Shanghai Daily said May 31, citing UBS AG. Inflation rose 5.3 percent last month, exceeding the government’s full-year target of 4 percent.

Moderating Growth

China’s gross domestic product may grow 9.5 percent this year, down from 10.3 percent in 2010, according to a median of 11 analyst estimates compiled by Bloomberg. Under S&P’s base- case scenario, China’s economic growth will moderate, while private consumption will remain strong, according to the report.

“The current situation isn’t a bubble and it’s not going to burst, but there is a risk,” Sprinzen said.

In case of a sudden slowdown in the world’s biggest consumer of commodities, iron ore’s floor is $85 to $95 a metric ton compared with about $170 now, seaborne coking coal at the mine has a floor of $100 to $120 a ton, compared with about $180 now, and hot rolled coil steel’s floor is $475 to $525 a ton compared with about $750 now, according to the report.

“In considering the downside for metals, we generally assume that the global industry production cost curve would set a pricing floor,” Sprinzen wrote. “Specifically, we assume that prices are unlikely to fall for an extended period below the level at which 10%-20% of world capacity cannot generate positive operating cash flow before investment.”

Commodities may “easily” drop 25 to 40 percent in the next 12 months, presenting an “enormous opportunity” for investors, David Stroud, chief executive officer of TS Capital, a hedge fund manager in New York, said in an e-mail today.

Markets are “starting to look a lot like 2008,” he said. That year, the GSCI dropped 43 percent.