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We continue to expect copper prices to increase in the near term, as China’s credit cycle bottoms and DM central banks soften their monetary-policy stance. Fiscal and monetary stimulus in China also will be supportive of base metals prices going forward. The evolution of the Sino - U.S. trade negotiations remains a risk to our view, given how important the outcome of these talks will be for investors’ expectations and sentiment. Markets appear to be discounting a positive outcome. Anything that scuppers these talks – or results in a no-deal outcome – will be a negative for base metals, copper in particular. Our tactical long copper position is up by 1.2% since we initiated it last week. Highlights Energy: Overweight. Russian oil companies are expected to keep production lower until July, when the current OPEC 2.0 production-cutting agreement now in place expires. We expect the deal will be extended to year-end.1 Separately, the risk of a complete shutdown in Venezuela’s oil industry rose significantly, as a power failure in most of the country all but eliminated potable water supplies and significantly reduced oil exports. Base Metals/Bulks: Neutral. High-grade iron-ore prices got a boost this week as Vale was ordered to temporarily suspend exports from its primary port at Guaiba Island terminal in Rio de Janeiro state, according to Metal Bulletin’s Fastmarkets.2 The price-reporting agency’s 62% Fe Iron Ore Index rose $1.46/MT at $85.25/MT Tuesday. Precious Metals: Neutral. Spot gold is back above $1,300/oz, on the back of monetary policy easing among important central banks. This also is supporting base metals globally (see below). Ags/Softs: Underweight. Grain markets continue to drift sideways, awaiting definitive news re Sino - U.S. trade talks, specifically when presidents Xi and Trump will meet to finalize a deal (see below). Separately, wheat and corn inventories are expected to rise on the back of higher supplies and lower exports, the USDA forecast in its latest world supply-demand estimates. Feature Recent data releases confirm our view that global growth will remain weak in 1Q19 and early 2Q19. This will continue to put downward pressure on cyclical commodities – chiefly base metals and oil (Chart of the Week). Chart of the WeekGlobal Growth Slows In 1Q19 Global Growth Slows In 1Q19 Global Growth Slows In 1Q19 The persistence of the slowdown provoked major central banks to adopt a dovish stance in the short-term. This is easily seen in the recent actions by the U.S. Fed, the European Central Bank (ECB), the Bank of Canada (BoC) and the Reserve Bank of Australia (RBA), all of which have communicated a pause in their rate normalization policies.3 At the moment, the frail global growth is partly balanced by expectations of a positive outcome re the ongoing Sino - U.S. trade negotiations (Chart 2). In the coming months, we expect the effect of accommodative DM monetary policy combined with an expansion in China’s credit (more on this below) and fiscal stimulus – i.e., tax cuts announced earlier this month amounting to almost $300 billion (~ 2 trillion RMB) meant to support policymakers’ GDP growth targets – will go a long way toward reversing the earlier contraction. The effect of these policy decisions will be apparent in 2H19. Chart 2China Growth To Hook Higher China Growth To Hook Higher China Growth To Hook Higher China’s Credit Cycle Bottomed In December 2018 The evolution of China’s credit cycle remains a central pillar to our view commodity demand growth in 2H19 will surpass consensus expectations. The massive growth reported in China’s January credit statistics revived investors’ expectations that China’s banks will re-open the credit valves as they did in 2016.4 In our view, this number does signal a bottom in China’s credit cycle, and implies Chinese – and indirectly EM – growth will bottom sometime this year. However, we still are not expecting a complete blowout credit expansion this year. We continue to believe Chinese policymakers will focus on stabilizing credit in 1H19 with moderate increases in supply, and start increasing stimulus in 2H19 or 2020 in order to maximize its effect later in 2020 ahead of the 100th anniversary of the founding of the Chinese Communist Party (CCP) in 2021. The soft February credit number released this week supports this argument.5 China’s Credit Cycle Matters For Base Metals Demand The relationship between China’s credit cycles and base metal prices endures and remains robust. We measure China’s aggregate credit using bank and non-bank claims on non-financial enterprises, households, local and central governments, and non-bank financial institutions. This corresponds to adding outstanding central and local government bonds to China’s Total Social Financing (TSF).6 The annual change in aggregate credit – or its impulses – do not perfectly capture the cycles in global base metal demand. These variables provide interesting signals about the direction and magnitude of movements in credit, however, they do not track base metals’ price cycles accurately and consistently (Chart 3). Chart 3Metals Price Cycles Don't Track Changed In China's Credit Metals Price Cycles Don't Track Changed In China's Credit Metals Price Cycles Don't Track Changed In China's Credit To decompose this variable into its trend and cycle, we use a proxy of the credit cycle constructed using the Hodrick-Prescott and Hamilton filters, and the standardized 12-month credit impulse (Chart 4).7 Chart 4China's Credit Cycle Proxy China's Credit Cycle Proxy China's Credit Cycle Proxy We find that our credit cycle proxy Granger causes base metal prices, import volume and industrial activity (Table 1).8 On average, it leads these variables by 4-6 months (Chart 5). Hence, we believe our credit cycle proxy provides valuable information about future commodity demand in China. Table 1China Credit Cycle Correlations Bottoming Of China's Credit Cycle Bullish For Copper Over Near Term Bottoming Of China's Credit Cycle Bullish For Copper Over Near Term Chart 5 In fact, when regressing copper prices and the LMEX against it, we found that 60% and 58% of the variation in copper prices and the LMEX, can be explained by the linear relationship with our China credit cycle proxy, respectively (Chart 6). Chart 6China's Credit Cycle and Metals Prices China's Credit Cycle and Metals Prices China's Credit Cycle and Metals Prices Given the leading property of China’s credit cycles with respect to industrial activity and metal prices, we included this new proxy in our Global Industrial Activity (GIA) index.9 This improves the correlation of our index with copper prices (Chart 7). Chart 7Credit Cycle Improves BCA's GIA Credit Cycle Improves BCA's GIA Credit Cycle Improves BCA's GIA Currently, our models suggest copper prices should increase in the coming months as China’s credit cycle bottoms and DM central banks soften their monetary policy stance. The evolution of the China-U.S. trade negotiations remains a risk to our view as the outcome will weigh on investors’ expectations and sentiment. China’s Vs. DMs’ Credit Cycles Between 2009 and 2014, China’s credit cycle lagged the U.S. and EU’s broad money cycles (Chart 8). This counter-cyclicality is partly explained by its elevated level of exports to the U.S. and of hard goods to Europe. When the global economic cycle works in China’s favor – i.e., when the Fed and ECB are accommodative or fiscal stimulus is deployed in either or both regions – China’s exports rise as U.S. and EU aggregate demand increases. This typically reduces the need for endogenous fiscal or monetary stimulus within China. Chart 8China's Credit Cycle Lags U.S., EU Money Cycles China's Credit Cycle Lags U.S., EU Money Cycles China's Credit Cycle Lags U.S., EU Money Cycles On the other hand, when the global economic cycle contracts and fiscal and monetary policy ex China becomes a headwind, Chinese policymakers typically need to deploy fiscal and monetary policy to keep growth going, or at least avoid a contraction in their economy. Between 2016 and 2017, DM and China credit cycles aligned and increased simultaneously. Taking into account the 4-to-6-month lag between the time credit supply is increased and commodity demand rises, this created bullish conditions for metals and oil from 2H16 to 1H18, pushing copper prices up by 60%. In 2018, both regions’ cycles rolled over. Base metals markets currently are experiencing the consequences of this contraction in credit availability and tightening of financial conditions generally. Going forward, we expect China will step in to raise domestic demand and offset the impact of the decline in credit availability elsewhere, which is affecting demand for its exports in the short-term. In the medium-term, the U.S. and EU, along with India, do not appear to be inclined to absorb Chinese exports to the extent they did in the past, which means the pivot to domestically generated growth through consumer- and services-led demand is the most viable alternative Chinese policymakers have to keep growth on target. Bottom Line: The dovish turn of major DM central banks combined with a bottoming of China’s credit cycle will support cyclical commodities at the margin in the coming months. During the second half of this year, we expect a more significant pick up in China’s credit, setting the stage for a year-end rally in base metal prices. As a consequence, the impact of China’s credit growth on base metals demand could diminish compared to previous stimulus targeting industrial demand.   Hugo Bélanger, Senior Analyst Commodity & Energy Strategy HugoB@bcaresearch.com Robert P. Ryan, Chief Commodity & Energy Strategist rryan@bcaresearch.com   Footnotes 1      Please see “Russia’s oil companies ready to cut output until July: TASS,” published by reuters.com March 12, 2019. 2      Please see Fastmarkets MB’s Daily Steel, March 12, 2019. 3      Please see “Pervasive Uncertainty, Persuasive Central Banks,” published by BCA Research’s Global Fixed Income Strategy March 12, 2019. It is available at gfis.bcaresearch.com. 4      Please see “China Macro And Market Review,” published by BCA Research’s China Investment Strategy March 13, 2019. It is available at cis.bcaresearch.com. 5      See footnote 4 above. 6      For more details please see “EM: A Sustainable Rally Or A False Start?” published by BCA Research’s Emerging Market Strategy March 7, 2019. It is available at ems.bcaresearch.com. 7      Hamilton notes the HP filter can be problematic. In general, we agree with critics of the filter (i.e. it results in spurious dynamics that are unrelated with the true data-generating process, it has an end-point bias which affects its real-time properties, and it is highly dependent on the parameter selection). However, there are some arguments in support of using the HP filter to proxy the credit cycle. First, as long as there are no clear theoretical foundation for an accurate measurement of the credit cycle, empirical validation should remain the number one criteria by which one selects its proxy. Second, credit cycles vary in duration and this weakens the ability to construct a reliable proxy. The usual parameter used with the HP filter favors short-term cycles (i.e. ~ 2 years) while the Hamilton filter focuses on medium-term cycles (i.e. ~ 5 years). Therefore, both can convey useful information. Third, China’s aggregate credit variable in level has a quasi-linear trend and is roughly approximated by a trend-stationary process with breaks in the trend and constant. Such a process should converge in limit when decomposed using the HP filter. Please see James D. Hamilton (2018), “Why You Should Never Use the Hodrick-Prescott Filter,” The Review of Economics and Statistics, vol 100(5), pages 831-843. and Phillips, Peter C. B. and Jin, Sainan (2015), “Business Cycles, Trend Elimination, and the HP filter,” Cowles Foundation Discussion Paper No. 2005. 8      Granger causality refers to a statistical technique developed by Clive Granger, the 2003 Nobel Laureate in Economics, which is used to determine whether one variable can be said to have caused (or predicted) another variable, given the past performance of each. Using standard econometric techniques, Granger showed one variable can be shown to have “caused” another, and that two-way causality also can be demonstrated (i.e., a feedback loop between the variables can exist based on the historical performance of each). 9      Please see “Oil, Copper Demand Worries Are Overdone,” published by BCA Research’s Commodity & Energy Strategy February 14, 2019. It is available at ces.bcaresearch.com. Investment Views and Themes Recommendations Strategic Recommendations Tactical Trades Commodity Prices and Plays Reference Table Trades Closed in 2019 Summary of Trades Image ​​​​​​​

Highlights February’s credit release earlier this week confirmed that credit growth is not yet on a “blowout” trajectory. If maintained, the recent pace of credit expansion implies a moderate credit cycle, not a large acceleration like what occurred in 2015/2016. We agree that a trade deal between China and the U.S. is likely to occur, but a sustained, cyclical (i.e. 6-12 month) rise in Chinese relative equity performance requires stability in the outlook for earnings, which have not yet reflected the ongoing economic slowdown. A confirmed meeting date between Presidents Trump & Xi coupled with more evidence that a moderate credit expansion is underway would likely lead us to upgrade our cyclical stance towards Chinese investable stocks (to overweight). Feature Tables 1 and 2 on pages 2 and 3 highlight key developments in China’s economy and its financial markets over the past month. On the growth front, data releases later this week will provide a crucial read on the pace of the slowdown in coincident economic activity. The ongoing weakness in trade and producer prices suggests that activity has continued to decelerate as the previously beneficial trade frontrunning effect washes out of the data. While we agree that January’s gargantuan credit number means that growth will bottom at some point this year, the February data released earlier this week highlights that credit growth is not yet on a “blowout” trajectory. If maintained, the recent pace of credit expansion implies a moderate credit cycle, not a large acceleration like what occurred in 2015/2016. Table 1China Macro Data Summary China Macro And Market Review China Macro And Market Review Table 2China Financial Market Performance Summary China Macro And Market Review China Macro And Market Review From an investment strategy perspective, we recommended in our February 27 Weekly Report that investors place Chinese investable stocks on upgrade watch, but that an immediate shift to a cyclical overweight was not yet warranted. The recent outperformance of investable stocks vs. the global benchmark largely reflects global investor expectations of a trade deal between China and the U.S. in the very near future, which we agree is likely to occur. But we have underscored that a sustained, cyclical (i.e. 6-12 month) rise in Chinese relative equity performance requires stability in the outlook for earnings, which have not yet reflected the slowdown that is underway. Barring a substantial trade-deal-driven rise in the RMB (which would dampen profits further and raise the bar for credit), a confirmed meeting date between Presidents Trump & Xi coupled with further evidence that a moderate credit expansion is underway would likely lead us to upgrade our cyclical stance towards Chinese investable stocks (to overweight). In reference to Tables 1 and 2, we provide several detailed observations concerning developments in China’s macro and financial market data below: The January and February data for several measures of coincident activity, including both measures of the Li Keqiang index (LKI) that we track, are set to be updated tomorrow. However, a number of data series that have been released over the past two months point to a continued deceleration: growth in rail cargo volume ticked down in January, producer prices are on the cusp of deflation, and nominal import and export growth decelerated again in February (measured either in US$ or RMB terms). The four components of our LKI leading indicator available for February have all sequentially declined, including the growth in adjusted TSF and adjusted TSF as a share of GDP. Credit had surged in January, but ticked down in February. Chart 1 illustrates the likely path of adjusted TSF as a share of GDP if the average pace of credit growth over the past three months is sustained. The chart implies that credit will have durably bottomed, but that the pace of advance will be weaker than that experienced in past cycles. Chart 1The Recent Pace Of Growth Implies A Moderate Credit Cycle The Recent Pace Of Growth Implies A Moderate Credit Cycle The Recent Pace Of Growth Implies A Moderate Credit Cycle ​​​​​​​ January and February data for residential floor space started and sold will also be updated tomorrow, and it will be important to see whether the gap that has emerged between construction and sales has persisted. Floor space sold has reliably led starts since 2010, and we recently highlighted that the PBOC pledged supplementary lending program has led sales since 2015. The pace of PSL decelerated further in February, suggesting that the outlook for sales (which are already in negative YoY territory) is deteriorating. Based on the leading relationships that we have identified, residential construction volume is unsustainably strong. The seemingly inconsistent messages between the NBS and Caixin manufacturing PMIs in February (down and up, respectively) may in fact reflect the PBOC’s focus on easing financial conditions for small businesses. While the NBS PMI includes a much broader sample of firms than the Caixin PMI, the latter focuses heavily on private sector SMEs. Given this, February’s data may suggest that the export outlook is improving, but we would caution against the conclusion that the overall manufacturing sector has bottomed until both PMIs are clearly rising. Over the past month, the most notable development in China’s equity market has been the near-vertical outperformance of A-shares versus the global benchmark. A catch-up period for A-shares was arguably warranted given the sustained rally in investable stocks since early-November, but Chart 2 highlights that the speed of the recent rise has pushed relative A-share performance quickly into overbought territory. At a minimum, a period of consolidation over the coming few weeks is likely. Chart 2Too Far, Too Fast Too Far, Too Fast Too Far, Too Fast ​​​​​​​ The relative performance of EM stocks ex-China is one of the equity components of our BCA Market-Based China Growth Indicator, which has recovered over the past few months. However, Chart 3 highlights that the performance of EM ex-China reliably led Chinese investable stocks since the beginning of last year, and are now raising a red flag. A near-term relapse in investable equity performance would be consistent with our view that earnings face further downside risk over the coming few months. ​​​​​​​Chart 3EM Ex-China Is Flashing A Warning Sign For Chinese Investable Stocks EM Ex-China Is Flashing A Warning Sign For Chinese Investable Stocks EM Ex-China Is Flashing A Warning Sign For Chinese Investable Stocks Within the investable equity market, our low-volatility sector portfolio remains in an uptrend versus the broad market, although the composition of this portfolio has shifted significantly over the past few weeks. Financials, industrials, and energy stocks now account for 86% of our long MSCI China Low-Beta Sectors / short MSCI China trade, which is likely surprising to many investors given their traditionally cyclical characteristics. Chart 4 highlights that the relative performance of our low-beta trade has exhibited a reliably counter-cyclical message; this, in combination with the fact that it remains above its 200-day moving average, signals that it is still premature to shift to a cyclical overweight stance favoring Chinese stocks. Chart 4No Green Light Yet From Low-Vol Stocks No Green Light Yet From Low-Vol Stocks No Green Light Yet From Low-Vol Stocks Value stocks have been responsible for more of the rally in China’s investable market versus the global average than their growth peers (Chart 5). This underscores that at least part of the rise in investable performance has been due to a relative valuation trade, rather than strong conviction that the Chinese economy will strengthen materially over the coming year. Chart 5The Rally Has Been Led By Cheap Stocks The Rally Has Been Led By Cheap Stocks The Rally Has Been Led By Cheap Stocks Table 2 highlights that the 3-month interbank repo rate is down materially from its 12-month high, a decline that is now passing through into lower bank lending rates. According to the PBOC, the weighted average lending rate declined 30 basis points in Q4, after having been essentially unchanged in Q3. The decline validates our model for predicting the rate, which had been calling for a non-trivial decline. Despite the continual expression of concern in the financial press about rising onshore corporate bond defaults, spreads on SOE corporate bonds have been steady over the past 6 months. Spreads remain elevated when compared with late-2016 levels, but the recent trend in spreads does not suggest that domestic financial conditions are getting tighter. Chart 6 shows that the recent rise in CNY-USD is consistent with a tariff-based framework that we had presented for the exchange rate several times last year. While the rate was on its way to breaking through the psychologically important level of 7 for USD-CNY, trade talks with the U.S. have helped the rate rise to a point that is consistent with the current tariff regime. CNY-USD has already overshot to the upside based on interest rate differentials, but Chart 6 implies that further gains may occur if tariff rollbacks are part of an eventual deal with the U.S. Chart 6CNY-USD May Rise Materially Further If Tariffs Are Rolled Back CNY-USD May Rise Materially Further If Tariffs Are Rolled Back CNY-USD May Rise Materially Further If Tariffs Are Rolled Back Jonathan LaBerge, CFA, Vice President Special Reports jonathanl@bcaresearch.com Cyclical Investment Stance Equity Sector Recommendations