From December 17 last year to yesterday—less than five months—the prices of threaded steel rose by 62%, iron ore by 65%, coking coal by 53%, and coke by 72%. The returns on commodity investments have far exceeded those of any other asset class. Gross profits per ton of threaded steel and hot-rolled steel reached 372 yuan and 400 yuan, respectively—nearly the highest levels since August 2009. This round of price increases has once again challenged our conventional understanding.

Text | Miner Ge

1. The rise in commodity prices has been utterly frenzied!

In the public perception, China’s coal, steel, cement, nonferrous metals, and other industries are suffering from severe overcapacity, with prices continuing to decline. As a result, businesses are struggling to stay afloat, leading to industry-wide losses, large-scale closures and restructurings of enterprises, sharp declines in wages, and massive layoffs in the industrial sector—creating an exceptionally grim situation.

However, since the 2016 Spring Festival, domestic black commodity prices have continued to strengthen, with futures contracts for coking coal, coke, threaded steel bars, and iron ore repeatedly hitting their daily limit-up levels. Just last night during the overnight trading session, the main contracts saw the following performances: iron ore rose by 5.3%, coke surged by 5%; coking coal and thermal coal climbed by 3.8% and 2.8%, respectively. Threaded steel bars gained 5.2%, with intraday gains once exceeding 7%; hot-rolled coil plates rose by 2.9%, with intraday gains at one point approaching 5%. The gross profits of some commodities have reached their highest levels in nearly seven years.

Historically speaking, even during the government’s massive economic stimulus in 2009, profits have rarely been this high, and the period of such high profitability has never exceeded three months—most often lasting around two months. Even more puzzling is that on April 20, while prices of bulk commodities such as coal, steel, and nonferrous metals were soaring wildly, stocks in these industries were plummeting instead.

II. So, who orchestrated this round of madness?

The increase or decrease in demand determines the prices of coal, iron ore, and steel, while supply-side reforms dictate the slope of their price trends. In summary, changes in the supply-demand dynamics are driving this round of price increases:

Demand side:

First-quarter data show that government investment in infrastructure, real estate investment, and credit issuance all saw substantial year-on-year growth, driving demand for bulk raw materials such as midstream steel, construction materials, and cement. As a result, demand for iron ore and coal rebounded sharply.

Supply side:

The head of the National Bureau of Statistics revealed yesterday that both domestic steel and coal production posted negative growth in the first quarter of this year. Specifically, crude steel production fell by 3.2%, and raw coal production declined by 5.3%. The contraction in production capacity and low equipment utilization rates have resulted in limited supply elasticity. Meanwhile, corporate inventories are at historically low levels, leading to an overall decline in supply.

International side:

First, market expectations of a delayed Federal Reserve rate hike have led to continued depreciation of the U.S. dollar. Second, with economies remaining weak, countries around the world have adopted quantitative easing policies, creating significant room for price increases. Third, BHP Billiton, the world’s largest iron ore producer, has lowered its iron ore production guidance by 10 million tons, while Rio Tinto announced that not only will its iron ore output remain unchanged, but it will also cut production by 20 million tons in 2017.

III. Will the prices of bulk commodities continue to rise?

For a long time, the mining industry has viewed 2016 as another extremely challenging year for China’s mining sector. However, in the first quarter of this year, prices of major mineral commodities have surged rapidly, seemingly signaling the arrival of spring for the mining industry. However, we still maintain our view that this is merely a fleeting phenomenon.

From a macroeconomic perspective, China’s GDP growth rate in the first quarter was 6.7%, marking the lowest quarterly growth rate since the reform and opening-up began—not the so-called “strong start.” The economies of developed countries such as the U.S., Europe, Japan, and South Korea continue to remain weak, with GDP growth rates showing no signs of improvement. Overall, global economic growth remains at its lowest level in a decade. Moreover, international institutions like Goldman Sachs still hold a relatively pessimistic outlook on the global economy.

Yesterday, a representative from the central bank indicated that monetary policy may need to return to a prudent stance, no longer relying heavily on stimulus measures to drive the economy and thereby avoiding sustained inflation. Once a prudent monetary policy is implemented, the artificial booms in the housing market, stock market, and commodity markets will quickly dissipate. There are also reports suggesting that the U.S. will raise interest rates in June; as the U.S. dollar strengthens at that time, it will likely lead to a decline in mineral prices as well.

From the demand side, influenced by the ongoing global economic slowdown, there is no possibility of a substantial increase in global demand for mineral products in the long term. The recent brief surge in demand for mineral products over the past quarter was driven by localized, limited, and short-term policy incentives—conditions that are unsustainable.

From the supply side, global production capacity for bulk commodities such as oil, coal, and iron ore continues to be released. The Doha freeze agreement collapsed, and the Brussels steel conference’s plan to limit production also fell through, signaling that the global supply of bulk commodities will remain persistently oversupplied. Influenced by the rebounding prices, even production capacities that had been shut down earlier are now showing signs of reactivation and planning to resume operations. Overall, the fundamental condition of global overcapacity remains unchanged.

Taking all the above factors into account, at least through 2016, the global oversupply situation in commodities will be difficult to improve, and a boom for the mining industry is unlikely to arrive. However, mineral prices will likely remain volatile at low levels, and short-term sharp rises or falls will be a normal occurrence.

Four, behind the frenzy lies China’s stopgap measure of relying on real estate to avert an economic hard landing.

In the fourth quarter of 2015, China’s GDP growth rate fell to a historic low of 6.8%, prompting numerous domestic and international institutions and experts to predict that the Chinese economy would experience a hard landing. Meanwhile, the adjustment and upgrading of the industrial structure will be difficult to accomplish in the short term; emerging strategic industries, though promising, cannot immediately address immediate needs. The internet economy has only enhanced economic efficiency without boosting overall economic output. Moreover, sluggish growth in export volumes is also failing to provide sufficient impetus for the economy.

Meanwhile, industries such as coal, steel, nonferrous metals, glass, and cement are suffering from severe overcapacity, leading to massive layoffs of workers and posing a threat to social stability. Under these circumstances, China’s economy faces the risk of a hard landing.

Faced with no other choice, we could only temporarily resort to the old approach of stimulating growth through investment. Thus, in the second half of 2015, a series of measures were successively introduced, including policies to boost the real estate market (reducing inventory), loose monetary policies, and infrastructure investment initiatives.

Yet this is unsustainable—on the one hand, we’re cutting overcapacity, while on the other, we’re using policies to boost demand. Since the beginning of this year, under mounting economic pressure, many cities have joined in efforts to stabilize their markets, which has helped revive both the economy and real estate investment, spurring a rebound in demand for commodities. However, this bubble-driven, illusory feast of wealth will only exacerbate inventory buildup, leading to ever-increasing amounts of ineffective investment and non-performing loans. If capital controls and foreign exchange restrictions are lifted, the bubble will burst swiftly, leaving everyone to experience an extremely painful aftermath—much like what happened in Japan and Hong Kong years ago.

For an economy that’s already showing signs of fatigue, it’s hard to expect it to bounce back immediately just by “injecting a shot and taking some medicine.” Moreover, excessively exuberant short-term behavior may not necessarily be beneficial for its long-term development.