China 10Y Yield vs. Copper Prices

In the past year, we have seen that commodity prices have been constantly reaching new highs despite the significant slowdown in global growth. Part of the slowdown has been coming from the sharp deceleration in Chinese economic activity amid the ‘zero-Covid’ policy that has been strongly weighing on growth expectations. As a result, China ‘fundamental’ indicators, which have historically strongly co-moved with commodity prices, have been significantly diverging from commodity indexes since early 2021 (China indicators show that the economy peaked in February 2021).

For instance, this chart shows that while market uncertainty has kept China 10Y yield close to historical lows, copper prices keep reaching new highs (China represents 50% of the demand for copper).

Two major reasons explaining that divergence are:

  1. Global supply chain disruptions (Covid disruptions, ‘natural disaster’ disruption i.e. South American droughts, and more recently the Ukraine war ‘shock).
  2. Investment narrative, with investors seeking for ‘inflation hedges’ with inflationary pressures soaring globally. Historically, commodities have been the best ‘inflation-hedge’ (particularly oil and nat gas).

Figure 2. China 10Y yield vs. copper prices

Source: Bloomberg

The question now is: can the divergence persist if inflation is peaking and is now expected to slowly but gradually decelerate?

Can the copper rally continue without Chinese ‘help’?

Copper was one of the major assets to benefit from the constant liquidity injections from central banks to prevent economies from falling into a deflationary depression. The front-month futures contract has more than doubled since its March low of 2.06 and is currently trading at 4.3, its highest level since August 2011.

However, we have also seen that copper prices (and other commodities heavily relying on Chinese economy) has been very sensitive to the annual change in China Total Social Financing (TSF). This chart shows that the annual change in China TSF 12M sum has been falling for the past 4 months, which has previously been associated with a correction in copper prices and other base metals. Can the momentum in copper continue without Chinese stimulus?

Source: Eikon Reuters