Will Australia continue to benefit from the commodities rally?

The rally in commodity prices that started in 2016 has greatly benefited the Australian economy so far. Will it last?

Data from the RBA shows how commodities bottomed in 2015/2016, and subsequently had one of the fastest gains in years.

Source: RBA April 2017

Key Australian exports such as iron ore, thermal coal and cooking coal all saw sharp price increases during this period.

Source: RBA April 2017

Driven by the rise in commodity prices, Australian terms of trade (prices of exports relative to imports) have improved dramatically over the past year. This had an almost immediate effect on nominal GDP, which is now growing at 6.1% year-on-year. At this rate, 2017 would have the strongest expansion in nominal GDP since 2011.

Source: Nikko Asset Management (via Barrons)

However, we are now seeing signs of a short-term slowdown in key commodity prices. Iron ore futures, for example, are at their lowest levels since November, and Copper also appears to be under pressure. This might raise questions about the sustainability of the commodities rally.

Source: The Wall Street Journal 

One of the major drivers of the commodity sector is the Chinese economy. More specifically, Chinese money supply growth has a particularly high correlation with commodity prices. “M1”, the most liquid part of China’s money supply, typically grows during fiscal expansions, when Chinese authorities want to stimulate economic growth. If M1 growth slows significantly, it could trigger a pullback in global commodity prices, so this is one key indicator to watch.

Chinese Money Supply vs Commodity Prices

Source: Financial Times

We don’t expect any significant reduction in Chinese monetary stimulus until at least the fourth quarter of 2017, when the 19th Communist Party Congress is expected to take place. As this is a sensitive political period, Chinese authorities will most likely avoid policies with unpopular consequences. Commodity prices should benefit from this, and so should the Australian economy.

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The information contained in this article is General in nature and has been prepared without taking into account your objectives, financial situation and needs.

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