Global Materials: Another Yuan Bites The Dust

Global materials equities are collapsing. The negative feedback loop of rising supplies, demand deficiency, price liquidation/deflation leading to declining profitability and investment, signals that the down-cycle is still in the early days. However, before getting overly bearish on the global basic materials sector, does it still make sense to avoid this heavily exposed commodity sector given the almost uninterrupted share price freefall since the 2011 relative performance peak?

The short answer is yes, owing to ailing commodity prices, decelerating growth in China, the global deflationary impulse, a rising U.S. dollar (especially given the August 11th policy U-turn on the renminbi) and waning industry operating metrics.

Over the past four decades, global materials relative share prices and commodity inflation have been joined at the hip (see Chart). Despite plummeting relative performance, materials stocks have only corrected to the long-term trend line. Not only are deflating commodity prices signaling additional pain ahead, but if history rhymes, it typically takes an undershoot in relative share prices to at least one standard deviation below trend before a trough is reached. Thus, there is ample downside left in relative performance if commodity prices stay weak.

For additional information on the outlook of the global materials sector you can access the Global Alpha Sector Strategy Report: “Global Materials: Another Yuan Bites The Dust”, dated September 11, 2015, available at

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Quantitative Tightening?

Fear mongering that equates Chinese reserve sales to an unwinding of central bank QE misses the broader point.


Our global fixed income strategists have no doubt that global yields would spike if the Fed, ECB or Bank of Japan were to begin liquidating their stocks of government bonds. It is a clear case of bond repricing due to the increase in the net supply that must be absorbed by the private sector. Fortunately, this is certainly not a near-term risk.

FX reserve adjustment is a more complicated story. As pointed out in last week’s Insight, there has been no consistent relationship between Chinese flows into Treasurys and the level of Treasury yields over the past 15 years.

More important for global bond yields will be the evolution of ex-ante savings and investment flows. The so-called “Global Savings Glut” (GSG) was evident before Lehman, but the Great Financial Crisis reinforced the reflex to save. Household savings rates jumped across the major countries, while the corporate sector built up cash as its financial balance shifted up. Meanwhile, government deficits exploded after 2007, but austerity is now well entrenched in many countries (i.e. the drain on the global pool of savings from the government sector is now waning). When all three sectors of the economy (households, corporates and governments) are simultaneously trying to save more or dissave less, interest rates fall.

A key part of the GSG story is China’s fixed exchange rate policy. China’s history of rapid export-led industrialization is well known. This involved a managed undervalued exchange rate, the encouragement of large amounts of FDI into the export sector, the accumulation of large amounts of official reserves, and the export of net Chinese savings through official intervention. An undervalued exchange rate discouraged domestic consumption, lifting the pool of saving available to the rest of the world. The fear for some time is that China will abandon this policy. Please see the next Insight, (Part II) Quantitative Tightening?