China is now a major par- ticipant in world commodity markets. The impact of China’s economic activity and its policies related to strategic reserve holdings, trade, and the environment are often seen as having a large impact on commodity prices. In turn, these commodity price changes can affect inflation and the terms of trade at the global level, with possibly large effects on other emerging and developing economics.
Understanding the scale of China’s impact on commodity prices is useful from a number of perspectives. First, it can help market participants better assess the balance of risks for prices, based on their own evaluation of prospects in China. Second, at a broader level, it can enhance policymakers’ collective understanding of the driving forces of commodity price changes. Recent discourse related to commodity market developments has increasingly focused on the role of financial speculation, the effects of which are sometimes estimated to be the unexplained part of commodity price changes once supply and demand factors are accounted for. However, this relies on an accurate assessment of these factors, including the changing role of China.
China is a large consumer of a broad range of primary commodities. As a percent of global production, China’s consumption during 2010 accounted for about 20 percent of nonrenewable energy resources, 23 percent of major agricultural crops, and 40 percent of base metals. These market shares have increased sharply since 2000, mainly reflecting China’s rapid economic growth. History has shown that as countries become richer, their commodity consumption rises at an increasing rate before eventually stabilizing at much higher levels. This is often described as the Scurve (See Figure 1).
But this cannot explain all of the increase in China’s commodity consumption. China’s commodity intensity of demand has been growing particularly fast and is now unusually high. Intensity is sometimes measured by commodity consumption per capita and this is shown, alongside real GDP per capita, for China and five other G-20 economies since 1980 for energy and 1960 for metals in Figure 2. Moving along the line in a northeast/ east direction traces the evolution of commodity intensity forward through time, from the first year in the sample to 2009. Based on this small sample of countries, China’s energy consumption is shown to be relatively high given its stage of economic development.
China’s role in international commodity trade only matters to the extent that it affects the relative distribution of supply and demand of different commodities across countries. For example, China’s strategic policy decision to strive for self-sufficiency in key grains but rely on imports of oilseeds has likely had major implications for global agricultural trade patterns. In terms of broad commodity groups, China has come to play a dominant role in base metals markets and, to a somewhat lesser extent, agricultural raw material markets. In contrast, China has not yet assumed a large role in global food and energy markets although its share of world imports is rising gradually (See Figure 2).
Effects of real activity growth rate shocks
A shock to real activity in China has a large and statistically significant impact on oil and copper prices, with less of an effect for other commodities. A one-time 1 percentage point (unit) shock to the real month-on-month growth rate of China’s industrial production leads to an increase in the real price of oil by about 2? percent after 4 quarters, with some slight moderation thereafter. The impact of the same activity shock on copper is to increase the real price by almost 2? percent after 4 quarters, again with subsequent slight moderation in price effects.
The price responses of other base metals to the China demand shock was, in general, smaller and statistically insignificant (although tin was borderline significant). In some cases, this reflects a production response for commodities with higher short-run supply elasticities. For example, the level of aluminum production increases by a statistically significant 0.4 percentage points 4 quarters after an initial activity growth rate shock in China. In part, this reflects the large aluminum smelting capacity in China and ready global availability of bauxite, the main raw material input for refined aluminum. In all other cases, including crude oil, short-run supply elasticities appear to be much lower, with the production response to a China activity shock insignificant in both statistical and economic terms.
The impacts of real activity growth rate shocks in China on global commodity prices are somewhat lower than those found for the United States, despite China’s increasing presence in global commodity markets.
Effects of commodity-specific country demand shocks
Commodity-specific demand shocks (controlling for economic activity) have no major effect on commodity prices (either in terms of their size or statistical significance). This was a consistent result across all commodities and for both China and the United States. Hence the results are not shown.
What can explain the absence of price effects from country-specific demand shocks? One possible explanation is that these shocks are perceived to be temporary and are accommodated by changes in inventories elsewhere, dampening the effect on prices. The time series properties of these shocks suggests that they are indeed partially unwound quickly; the cumulative effect on the level of commodity-specific demand more than halves after two quarters (i.e., for a unit shock, the cumulative change in demand is less than 0.5 percent higher).
This rapid unwinding is also true of shocks to real activity in China, but in this case the additional demand is likely to reflect actual use of the commodity (and a subsequent decline in world inventories, holding short-term supply constant). In contrast, while commodity-specific demand shocks may also represent higher consumption, they may also reflect increased Chinese precautionary demand for inventories. If this increased demand is quickly unwound, physical supply and demand are left broadly unchanged, which again would dampen the price effect. This would be particularly true if inventory holders in China were price sensitive and there is evidence to suggest that this is true, as shown next.
China is becoming increasingly important for commodity markets. Its role in the market and its impact on world trade and prices varies by commodity; in particular, China has become the dominant importer of base metals and agricultural raw material, with a smaller, but growing role, in food and energy markets.
I find that shocks to aggregate activity in China have a significant and persistent short-run impact on the price of oil and some base metals. In contrast, shocks to apparent consumption (in part reflecting inventory demand) have no effect on commodity prices. China’s impact on world commodity markets is rising but remains smaller than that of the United States. This is mainly due to the dynamics of real activity growth shocks in the U.S, which tend to be more persistent and have larger effects on the rest of the world.
Looking ahead, commodity market developments will increasingly be determined by China ― the only question is how big the China effect will be. Understanding how Chinese demand for commodities will change if and when its economy rebalances(away from investment and exports towards consumption) remains the biggest challenge for future research in this area.