Taking a closer look at the official Chinese PMI

While the official Chinese PMI went up, the miss on expectations will make many nervous, from copper bulls who need strong Chinese consumption to absorb rapidly building stocks and steel producers/traders who have accumulated large inventory on very strong production rates in early 2013.

Looking at the detail of the data, it does look like unusual movement in some of the components caused the headline to underwhelm.  Also for those concerned with commodities, falling materials inventory is not a bad thing, although it is a negative on the headline PMI.

The official PMI has this year been expanded to cover 3000 firms, but its construction remains the same.  As a diffusion index, each value represents the balance of positive responses (activity improving) vs. those responding negative and no change.  The headline index is a weighted index of 5 other components: New Orders (30%), Production (25%), Employment (20%), Supplier deliveries (15%) and Materials Inventories (10%).  Supplier deliveries are taken as a negative for the headline index, that is if the index rises (deliveries becoming faster), it makes a negative contribution to the PMI.

The headline Index is mostly driven by New Orders, Production and Employment. The chart on the left shows the monthly contribution from these components to the headline.  For example, for the most recent data point, New Orders, Production and Employment drove 1.5 index points of the total change in the headline index.

The chart highlights the March values over the last 4 years and shows that the most recent data is stronger than 2010 but weaker than last year.  So while its not particularly strong, these components probably haven't disappointed.

What was an usually large drag on the index was supplier deliveries and materials inventories. To be sure, the cumulative 0.6 index point drag from these components was the largest in the series history.

And while these are negative developments for the PMI, they are not particularly negative for the bigger picture.  While faster supplies could represent demand driven slack in the supply chain, it could also be a function of greater efficiency.

Falling materials inventories are also a good sign for those looking forward.  The inventories index has actually not been negative in March since the series began in 2005.

So the detail suggests that perhaps the miss in the headline PMI is not really bad news at all for commodities