Commodity research house of the year, Asia: Bank of China International

Energy Risk Asia Awards 2019: In-depth local knowledge combined with sophisticated global macro analysis differentiates Chinese bank’s research

Being competitive in commodities research today requires understanding a broader range of market indicators than ever before. A nuanced understanding of global supply-and-demand fundamentals – especially the more opaque ones – remains central. However, the financialisation of some commodity markets means price drivers now derive from a wide array of asset classes. Ascertaining which ones are exerting the strongest influence on commodities prices at any one time is extremely challenging. Additionally, the continuing heavy influence of China requires a deep understanding of Chinese economic policy and corporate sentiment.

Few research teams are expert in all of this, but the market strategy and research team at Bank of China International stands out.  

“The combination of our in-depth China knowledge with our global perspective is what differentiates us,” says Xiao Fu, head of commodity markets strategy. “We marry the best of the two worlds.”

For those outside China, the country’s economic policy can be confusing, she notes. Having an ‘insider’s’ understanding of Chinese policy gives her team an advantage over international banks, she believes. For example, on September 16 when China’s central bank lowered the reserve requirement ratio – the reserves that commercial banks are required to keep – it was widely interpreted by mainstream banks as modest monetary easing. However, the BOCI team saw it as a bigger event. “While there was a 50-basis point cut for large banks, there was an additional 100bp for smaller city banks. I think many mainstream banks missed that point,” she says.

The team also strives to achieve a thorough understanding of Chinese government policy on, for example, electric vehicles and initiatives such as Belt and Road – the multi-billion dollar infrastructure project spearheaded by China to improve links between China and the rest of the world.

“Belt and Road is going to reshape the trade flow and supply-and-demand patterns on the global commodities market over the medium to longer term,” Fu says. Her team has carried out extensive research into how the initiative will affect the supply and demand of commodities, looking into which regions are resource-rich and how, for example, newly expanded ports in Sri Lanka and Pakistan might open up new trade routes.

Additionally, the research team has close links with Chinese corporates, thanks to BOCI’s many longstanding relationships in onshore China. This enables the firm to cross-check their fundamental macro demand analysis with corporations on the ground. “Our research is all channel-checked with our local contacts, so we really do our homework,” Fu adds.

The combination of our in-depth China knowledge with our global perspective is what differentiates us. We marry the best of the two worlds

Xiao Fu, Bank of China International

Meanwhile, the bank differentiates itself from its Chinese competitors by its strong analysis capability and global perspective. “Chinese banks tend to focus only on China. But for us we want to be the international face for Bank of China, so we need a good global perspective,” says Fu.

The team has developed a global supply-and-demand model for all major commodities. The supply side breaks each commodity into regions and is very granular, while the demand side takes in macro economic indicators as well as bottom-up analysis with firms to cross-check. Data from sources such as the US Energy Information Administration and the Commodity Futures Trading Commission’s Commitment of Traders report feeds directly into the team’s reports, updating them automatically.

In the last year, BOCI has broadened its coverage to include bulk commodities and also deepened its analysis of energy, base metals and precious metals markets, says Fu. In particular, it has applied machine learning techniques to its research. A major example of this is the ‘Animal Spirit’ index. This is a dynamic index with 27 different underlyings that include commodities, equities, currencies and rates. It uses artificial intelligence to weight the underlyings and quantify market sentiment.

 “The model comes up with a number between +10 (meaning most bullish) and –10 (most bearish) to enable you to see whether the market is bullish or bearish and to what degree,” says Fu. “Combining this with our analysis of commodities fundamentals, we can derive our directional view.”

 The team has already used the model to make some prescient calls that went against consensus. For example, in the fourth quarter of last year when oil prices started to sell off, not many people expected a collapse. But the model showed market sentiment in other asset classes to be very bearish. “That was a big surprise for me,” says Fu. “I thought oil prices may be already sold, but the model indicated further weakness ahead and I was able to inform clients of what the model suggested.”

Indeed, between October 3 and December 24, 2018, oil prices dropped 41% from $86.30 a barrel (/bbl) to $50.80/bbl.

As the financialisation of oil markets creates stronger links between commodities and other asset classes, Fu believes this model will provide greater and more useful insights. “Sometimes the fundamentals of the commodities markets really dictate price movements, but other times wider market behaviour is the driving force, so those sentiment indicators can be extremely useful.”  

The team also correctly predicted the timing of this year’s gold rally, estimating that prices would surpass $1,500 an ounce. This followed its influential article on the impact of Belt and Road on gold that was published in October 2018 in the World Gold Council’s magazine.

“We’re very proud of this article due to its strategic value and the unique insight it gives into gold and commodities,” says Fu.