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China cuts capacity, commodities rally

After a strong US and European session, Asian markets are all looking for further gains today.

China
Source: Bloomberg

Volumes have been very light at the moment, but that has seemingly been positive news for markets across the region. News of copper output cuts in China and expectations for oil inventories to decline in today’s EIA data have set the scene for strong gains for materials and energy stocks in the region, as well as commodity-related currencies.

China

China’s commitment to cutting industrial overcapacity is beginning to look increasingly serious. The Central Economic Work Conference (CEWC) announced an intention to see industrial capacity cuts. This statement seems to have just put a voice to a trend that was already underway. In any case, it has been interesting to see the very positive moves in industrial metals in response to China’s steady industrial capacity cuts. Yesterday, 9 Chinese copper smelters announced a commitment to cut copper sales by 200,000 metric tons in Q1 2016. In response, copper March futures rallied 2.8% and these moves have been mirrored across the metals space with zinc, aluminium and iron ore all gaining overnight as well. The issues going forth will be trying to deal with the inevitable jump in unemployment associated with cutbacks, and smoothing the feathers of local government as they see the disappearance of major drivers of local economic activity. Nonetheless, these developments bode well for the performance of materials sectors in both the Australian and Chinese indices. BHP and RIO still closed in negative territory on the FTSE 100 overnight, and currently are looking to open down, but after yesterday’s poor performance there is a good chance they’ll both finish in the green today.

Oil

WTI oil has bounced back 2.9% overnight ahead of expectations for a further 2.5 million barrel decline in the weekly EIA inventories report. There have also been growing reports of some cold fronts coming into the Northern hemisphere to dissipate their unseasonally warm winter and hopefully pick up energy demand. Of course, trading volumes are down by half in these oil contracts so it is difficult to read too much into the recent bounce in prices. The drop from Iran’s announcement this week relates to longer-term structural issues with the market, whereas the bounce in expectations for a drop in weekly inventories is a far more ephemeral price stimulus. Indeed, with WTI beginning to trade at a premium to Brent, the possibility for an influx of foreign oil imports adding to US oil inventories becomes increasingly likely. The current oil price levels continue to look more like good entry points for further short positions. Nonetheless, energy stocks look set to benefit during Asian trade today.

Commodity currencies

Coinciding with these moves in the commodity space has been a big jump in commodity-related currencies overnight. The Aussie, CAD and Kiwi were the top performers of the G10 currencies. The 0.7% gain in the Aussie put it back over US$0.73 since 11 December. Although looking ahead, the Aussie has normally encountered strong resistance around the US$0.7350 level over the past three months, usually prompting a selloff soon after hitting that level.

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