These Two Assets May Gleam Especially Brightly With China’s Reopening

In terms of market-moving events, they don’t get much bigger than what’s going on in China right now. The government’s decisions to reverse its Covid restrictions and to inject its moribund property market with fresh stimulus are huge. It means a boost for stocks, sure, but also for the stuff right under your feet. And Morgan Stanley believes that two commodities – iron ore and aluminum – are in prime position to benefit. So I did a little mining of my own to find out why…

How big of a deal is China to commodities?

It’s massive. The world’s second-biggest economy dominates global metals demand because of its huge property sector, general infrastructure needs, and massive manufacturing industry. China makes up over 70% of global iron ore demand and nearly 60% of aluminum demand. It’s clear then that as China gets back to full health, it’s going to have an outsized impact on the prices of those two commodities.

China’s share of global commodities demand in 2021. Sources: ICA, IAI, ILZSG, WSA, Nickel Institute, IEA, and Morgan Stanley Research.

And Morgan Stanley sees that return to health happening quickly. It’s forecasting that the Chinese economy will grow by 5.7% this year, well above the 4.8% consensus prediction. The investment bank says its view has been buoyed by China’s speedier-than-expected reopening, housing sector support, and its new, friendlier regulatory environment for tech. What’s more, it says, post-lockdown, Chinese consumers are sitting on piles of savings – more than $440 billion – and ready to unleash a surge of growth-sparking spending.

OK, so why iron ore in particular?

The raw material used to make steel has been rocketing in recent months, trading recently around $124 a ton, compared to $81.50 back in November. Before you go thinking that there’s no juice left to squeeze, Morgan Stanley argues that iron ore has room to move higher. See, Chinese steel production (blue line) and iron ore’s price (orange line) usually move hand in hand. But iron ore’s price is just recovering from a sluggish period, and with production likely to rebound from its recent dip (gray shaded oval), iron ore’s price is jolting awake.

China’s steel production and iron ore price. Sources: Mysteel, Platts, and Morgan Stanley Research.

China has a huge backlog of infrastructure projects – work that was sidelined during last year’s Covid lockdowns plus a whole lot of new, spring 2023 construction projects. This year’s investment alone would be a record, with China’s grid slated to see $4 billion in improvements.

Globally, there’s expected to be less iron ore to go around: seaborne supply (i.e. the commodity moved by ships) is forecast to slow in the first half of this year. We saw this pattern play out over the past two years as well: for example, the four biggest iron ore exporters (Canada, South Africa, Brazil, and Australia) shipped 9% less in the first half of last year compared to the second. What’s more, this year heavy rainfall in Brazil is causing some disruptions.

As a result of all this, Morgan Stanley sees upside for iron ore. It’s forecasting a price of $140 per ton by the second half of the year.

And why aluminum?

Among base metals – i.e. those useful workaday industrial metals – aluminum is Morgan Stanley’s top pick. That’s because China is the world’s biggest exporter of the stuff but also, as a manufacturing giant, it consumes a huge amount of it.

What matters for the price of aluminum most is how much China actually sends out into the global market – and that’s determined by both its domestic production and its demand appetite. For the past six months, China’s exports have been falling rapidly and inventory levels at the Shanghai Futures Exchange have been following suit despite fairly stable production.

China’s aluminum exports. Sources: China Customs and Morgan Stanley Research.

Aluminum is used in all kinds of products. It’s in cans, foils, kitchen utensils, and beer kegs. It’s also important for home builders (it’s used in window frames, for example) and for electric vehicle manufacturers.

And with China’s factories open again and its housing market set for a resurgence, China’s demand for this lightweight metal is about to become really heavy indeed. It’s estimated that China’s new property stimulus measures will push home completions up by 20%. What’s more, with China’s economy as a whole rebounding, there’s expected to be increased demand across all kinds of consumer goods, many of which require aluminum packaging.

Meeting that demand could be a challenge. China’s recently been struggling to power some key aluminum production facilities in Yunnan and Guizhou. And with the economy rebounding, that’s only going to exert more pressure on the electrical grid, which could constrain smelting capacity (a process required to extract aluminum from raw materials).

Europe’s aluminum production is coming up a bit short as well, with about 27% of capacity curtailed because of higher energy costs, even despite the recent easing in prices on the continent. And that could widen the supply-demand imbalance even more.

Morgan Stanley sees aluminum rising to $2,800 per ton before the second half of the year, but says it could go as high as $3,360. It was trading Friday at $2,477.

So what’s the opportunity then?

If you’re looking to diversify your portfolio beyond stocks, and see China driving a good year for aluminum and iron ore, you could consider buying the iPath Series B Bloomberg Aluminum Subindex Total Return ETN (ticker: JJU; expense ratio: 0.45%) and the VanEck Steel ETF (SLX; 0.55%).