The emergence of a major new commodities cycle has been one of the dominant investment themes of 2021, with high-growth tech now falling to the wayside.

And while the US government has flagged a big post-COVID infrastructure push, the near-term demand story has been all about China.

In research this week, UBS noted that Chinese Premier Li Keqiang has now “stressed the need to control surging commodity prices” for the second time in two months (April and May).

Among the broader ASX selloff yesterday, big miners were hit hard as China said it would ramp up domestic exploration efforts and look to source iron ore from other external sources.

While trade tensions are evidently still a factor, China currently sources around 60 per cent of its iron ore from Australia, so a near-term supply switch looks unlikely.

And while UBS conceded it has “no visibility into the specific actions that China may take”, the bank flagged two measures China could take that may help to cool price gains in iron ore and base metals.

Export cuts

A key support measure for Chinese iron ore demand is that margins for Chinese steel mills remain robust which means they are able to absorb the higher prices.

UBS said those margins are in part a function of global steel demand, as major economies rebound out of the pandemic.

In fact, finished steel exports out of China rose to 82 millions tonnes for the year ended April 30 — the highest level since 2016.

“High steel spreads have incentivised record steel output (despite restrictions in Tangshan) & in turn strong demand for iron ore,” UBS said.

So in that context, a ban on Chinese steel exports would increase supply for the domestic market and push prices down, while also reducing end-demand for steel more broadly which would feed through to lower iron ore prices.

In turn, ongoing demand from other major global economies would see end-user steel prices move higher, if China stepped back from its role as a global steel supplier.

Hit the sell button

On the base metals front, another option to cool prices could come via a directive from China’s State Reserve Bureau (SRB) to sell inventory.

UBS noted that authorities flagged possible sales of aluminium inventories back in March.

Since then, prices have risen by another 10-15 per cent so “the risk of selling is lifting”.

“We see limited signs of real tightness in China metals markets, and in the past this has been the main reason why the SRB has sold reserves,” UBS said.

However, if commodity prices continue to inflate it could be an option on the table.

Domestic inventories of aluminium and zinc are only large enough to prompt smaller near-term price drops, UBS said.

However, the bank estimates the SRB holds around 2-3 million tonnes of copper inventories, which means stock sales “could have a more material & lasting impact on supply and demand”.