Manufacturing a Case for Chinese Soybean Demand
Picture in your mind a Fire Monkey. What does it look like? Your guess is as good as anybody's; it's a mythical zodiac creature, but it is known to be aggressive and mischievous. Now imagine that the Fire Monkey is rapidly running toward you.
The Chinese Year of the Fire Monkey, determined by the lunar calendar, will arrive in about a month, starting on February 8 of the Gregorian calendar. According to legend, it is expected to be a year of great risk in business and the economy.
Getting things off to a bit of an early start, Chinese investors already started shedding risk exposure on the first and second trading days of the 2016 calendar year. The Shanghai Composite Index dropped 7% this Monday, following that with continued losses Tuesday. It's thought that up to 90% of Chinese stock market participants are inexperienced individual retail investors, whose outlooks are more susceptible to fear and cascading rumors than long-term institutional investors may be. For the past six months after last summer's meltdown, large holders of Chinese listed stocks have been banned from selling off their positions. That ban is set to expire on Friday, thus justifying some legitimate fears about an upcoming liquidation stampede. Or possibly the government will continue to artificially prop up the stock market by extending the ban. No one seems to know yet.
Regardless of guesswork, there was also fundamental data to back up the bearishness. The Chinese manufacturing sector showed negativity for the fifth-straight month, with a PMI (Purchasing Managers' Index) of 48.2 in December. Anything below 50 implies contraction. (Incidentally, the United States' December manufacturing PMI was also 48.2.)
For the U.S. soybean market, though, the more interesting number was China's non-manufacturing PMI from December, at 54.4, showing that the service sector of that country's economy continues to grow. There is great temptation among soybean market bulls to tell themselves that as long as China's domestic consumer market remains strong, as long as Chinese people keep eating pork and poultry and as long as Chinese hogs and chickens keep eating soybean meal, then whatever fireworks may occur in the fizzling Chinese manufacturing sector shouldn't affect overall soybean demand.
Fortunately, I was able to more or less confirm this idea, without even torturing the data too much. For one thing, it has always been true that food commodity demand is less elastic than that of other commodities. Bearish outlooks for commodity prices in 2016 are more applicable to energy markets and industrial metal markets than to agricultural markets. In the event of widespread global financial instability, humans will be quicker to change their plans for building and moving and starting new lines of business than they will be to change their never-ending desire to eat.
More specifically, the historic trend of Chinese soybean imports -- steadily rising from 10.4 million metric tons in 2000/2001 to 80.5 mmt in 2015/2016 -- is more closely correlated to the growth of the country's domestic consumer segment than it is to the old-school manufacturing economy. If we look at an ETF that tracks the performance of a basket of small-capitalization companies within China, that can be a proxy for the economic activity of domestic consumers. For reference, I used the Guggenheim China Small Cap ETF (NYSE:HAO). Taking a look at the ETF's holdings, indeed it seems to be a lot of software companies, e-commerce, retail, and even a dairy corporation. Only in the broader market would you find the blue-chip Chinese stocks that represent the bigger mining/manufacturing/exporting picture, represented by the Shanghai Composite Index.
So it is the divergent picture suggested by these two data series -- the consumer small cap stocks versus the larger market with manufacturing stocks -- that allows us to peek at the diverging prospects for Chinese economic health. It turns out yes, in the years since the financial crisis, the consumer services sector has done better (up 7% since January 2008) than the overall market has done (down 25%). No surprise there.
And crucially, yes, the trend of Chinese soybean import demand has a stronger correlation to the performance of the consumer services sector (as represented by this ETF) than it does to the performance of the broader Chinese stock market.
This examination of data has been particularly muddy, however. That small-cap ETF is in no way a perfect representation of China's consumer service sector. The Shanghai Index, speculative-driven bubble that it may be in, probably isn't even a very good proxy for China's overall economy or its manufacturing sector. And of course, the connectedness and correlation between these data sets is about as spurious as the correlation between per capita cheese consumption and the annual number of people who die by becoming tangled in their bedsheets (which is quite strong, by the way).*
We must also ask ourselves: Of however many soybeans China imports in this marketing year or the next, what proportion will come from the United States? China's imports of soybeans and other oilseeds in the 2012-13 marketing year, from all countries including ours and our South American competitors, were equivalent to $39.6 billion U.S. The United States has been the No. 1 provider, shipping 36% of that market share. Through the next few months, however, Brazil and Argentina are likely to show up with a mighty quantity of competitive offers. This is especially troubling when one considers China's currency scenario.
Right alongside the stock market fall, the Chinese renminbi fell 0.6% Monday, its third-largest recorded daily fall. It's expected to keep falling through 2016, given the fair likelihood for continued monetary easing in January from the Chinese government (which is still able to cut interest rates). A weaker currency will only make Chinese soybean buyers more and more price sensitive -- and more and more so against American products (denominated in the ever-stronger U.S. dollar) compared to Brazilian products, which are sold by their producers in a currency that keeps falling right alongside the renminbi.
All in all, there are reasons to be optimistic that Chinese soybean consumption could be surprisingly resilient in this new year (no matter whether you measure the year by a commercial calendar or a lunar calendar). But I'm going to keep my eye on that Fire Monkey, especially with regard to currency competition.
Elaine Kub is the author of "Mastering the Grain Markets: How Profits Are Really Made" and can be reached at firstname.lastname@example.org or on Twitter @elainekub.
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