Open Door Policy

China’s Zero-Covid policy could not last forever, but the suddenness of the reversal was unexpected. China’s doors are opened once again. The initial reaction is one of optimism for global economic growth, but hurdles remain.

If we have learned anything about Covid, it is that once released, it spreads quickly. The Lunar New Year celebration could be the mother of all super spreading events, but that will only be known in retrospect. Any resurgence of demand in China could easily be delayed by a rapid disease spread.

More disease implies:

Fewer people working: An unchecked spread can quickly reduce the available workforce until the surge has passed.
More deaths: In the U.S., a high number of deaths among the working age population has contributed to a labor shortage. Could there be a similar effect in China? It’s difficult to imagine a labor shortage in China, but losing skilled workers permanently still presents its challenges.
New Variants: More disease means more opportunity for a new, difficult to control, variant to emerge. Impossible to predict, but something to monitor closely.

Eventually re-opening brings the Chinese manufacturing machine fully on line. In most of our experience, that has been a very good thing for stoking the coals of the global economy. This time, however, we also see some significant headwinds.

Supply chains for most hard goods are returning, or have returned, to normal. The backlog of container ships has disappeared and pent up demand is mostly satisfied.
China is the ‘manufacturer to the world’, but Covid has initiated a period where China will be losing market share, as the West on-shores or re-shores manufacturing, especially for items deemed strategic.
In addition, as manufacturer to the world, China is now susceptible to weak demand in the Western world as the West grapples with slow economic growth.
The Chinese real estate sector, which was the key driver of commodity demand over the last 20+ years, is suffering from mal-investment. New building will not be anywhere near the driver of demand that it was in the 20 years leading up to Covid.

On the other side of the coin, there are also some tailwinds:

There should be plenty of pent-up demand. The Chinese consumer is, in many ways, no different than western consumers. Once freed of restrictions, spending activity picks up. A big difference here may be that China did not employ massive stimulus packages as we did here in the States.
The Chinese real estate may be weak and saddled with debt, but the government is acting to avoid disaster. Property build-outs need to continue, albeit at a pace that is slower than recent history. Nonetheless, that is a net positive for commodity demand.
Winter energy turmoil in Europe did not materialize, as the first half of winter has been unseasonably warm. Even with a cold second half, gas supplies appear adequate, giving a boost to European economies and, in turn, demand for Chinese made goods.

The price of base metals (copper, iron ore, aluminum, etc.) has already begun to shoot up in anticipation of growing Chinese demand. Crude oil, however, has NOT followed that lead. Many experts are looking for a significant pickup in oil demand from China, to the tune of some 800,000 bbl/d, and therefore higher prices. On the other hand, this week, OPEC, arguably the best prognosticator of oil demand, left its estimate total demand growth in 2023 unchanged at 2.2 mm bbl/d. The OPEC report stated: “Minor upward adjustments to the 2023 forecast were made due to the expected better performance in China’s economy on the back of its reopening from Covid-19 restrictions, while other regions are expected to see slight declines, due to economic challenges that are likely to weigh on oil demand.” Crude prices may be the best real time indicator of recovery in China.

The bottom line is that the China re-opening after Covid will likely be as confusing as it has been elsewhere in the world. Don’t read too much into the prognostications, just watch the data.

Data Dump

Other than employment, economic indicators continue to point down. Here is a quick summary of this week’s data:

UNEMPLOYMENT CLAIMS: The number of first time filers for unemployment benefits plunged to 190k (below expectations of 214k). A huge drop in New York was the primary cause for the decline. Continuing jobless claims rose to 1.647 million from 1.63 million.

HOUSINGSTARTS & PERMITS: December housing starts were a bit better than expected, but permits were a bit worse. Here is a look at the longer term trend for both.

EXISTING HOME SALES: Existing-home sales declined 1.5% in December, the eleventh straight month of declines. The seasonally adjusted annual rate of 4.02 million is a decline of 34.0% from one year ago.

INDUSTRIAL PRODUCTION: US Industrial Production decreased 0.7% in December, lower than the 0.1% expected decline. November data was also revised downward to a decline of 0.6%.

RETAIL SALES: December retail sales declined 1.1% month-over-month. Expectations were for a decline of 0.8%. November sales were revised upward to a decline of 1.0%. Here is a look at the trend over the last year.