China's Easing Deflation: A Tactical Buy Signal for Commodity-Linked Sectors?

China's deflationary spiral, which deepened through much of 2025, has shown tentative signs of stabilization in late September, raising critical questions for investors: Is this a tactical inflection point for commodity-linked sectors, or merely a pause in a prolonged structural downturn? The answer hinges on dissecting the interplay between policy-driven sector rotation, global trade dynamics, and the uneven recovery of domestic demand.

Easing Deflationary Pressures: A Fragile Reprieve

According to a report by ReutersChina's producer deflation eases, helped by crackdown on price wars^[1], China's Producer Price Index (PPI) declined by 2.9% year-on-year in August 2025, narrowing from a 3.6% drop in July-a modest improvement attributed to Beijing's "anti-involution" crackdown on price wars in sectors like electric vehicles and solar panels. Similarly, the September 2025 CPI fell by 0.3% year-on-year, slightly better than the 0.4% contraction in AugustChina's producer deflation eases, helped by crackdown on price wars^[1]. These figures suggest that government interventions, such as interest rate cuts and consumer subsidies, are beginning to temper the deflationary spiral. However, the broader economic context remains precarious: the PPI has recorded deflation for 36 consecutive months, while consumer demand remains weak, driven by low household confidence and the property sector's collapseChina's Deflationary Shadow Deepens as September 2025 Data Looms^[2].

Sector-Specific Impacts: Winners and Losers in a Deflationary Environment

The deflationary tailwinds have created divergent outcomes across commodity-linked sectors. Overcapacity in steel, EVs, and solar panels has intensified price competition, compressing margins for manufacturersChina's producer deflation eases, helped by crackdown on price wars^[1]. For instance, pork prices plummeted 16.1% year-on-year in August 2025, dragging down the food CPI by 4.3%China's producer deflation eases, helped by crackdown on price wars^[1]. Conversely, firms aligned with strategic national goals-such as BYD and Xiaomi in the EV sector-have benefited from export demand and government support, despite aggressive domestic pricing.

Global markets are also feeling the ripple effects. Bloomberg analysts note that China's waning demand for industrial metals like copper and iron ore, coupled with U.S. tariffs on Chinese goods, has exacerbated global commodity oversupplyReflation or verge of deflation? Commodities vs. China, tariffs^[3]. Yet, this dynamic presents asymmetric opportunities: while domestic producers face margin pressures, global firms using Chinese inputs may enjoy cost advantages.

Sector Rotation Strategies: Navigating the Deflationary Landscape

Historical sector rotation strategies during Chinese deflationary cycles highlight a shift toward defensive sectors like healthcare and consumer staples, which maintain demand regardless of economic conditionsSector Rotation: Strategic Timing of Industry Investments^[4]. However, the 2025 context introduces new variables. The Chinese government's focus on "Dual Circulation"-boosting domestic demand while maintaining export competitiveness-has spurred targeted stimulus in infrastructure and green energy6 ways Chinese policy-making has prepared for trade disruption^[5]. For example, subsidies for consumer goods and interest rate cuts in August 2025 have bolstered sectors like tourism and cateringChina's producer deflation eases, helped by crackdown on price wars^[1].

Investors must also weigh the risks of policy overreach. Redirecting export surplus to domestic markets, as seen with JD.com's discounted sales initiatives, risks deepening deflation by further eroding pricing powerChina's economy on cusp of a deflationary death spiral^[6]. Meanwhile, structural reforms to reduce overcapacity in solar and EV battery manufacturing remain politically and economically complex, given the dominance of private firms in these sectorsWhat can really cure deflation in China? – Chin@Strategy^[7].

Global Implications and Risks: Tariffs, Trade, and the Path Forward

The U.S.-China trade war has intensified the deflationary challenge. Tariffs on Chinese exports-now as high as 145%-have forced manufacturers to consider overseas production, potentially creating new global supply redundanciesChina's Commodity Landscape: Key Themes in 2025^[8]. Goldman Sachs warns that this could prolong deflationary pressures, as redirected exports compete with domestic markets in advanced economiesChina risks deeper deflation by diverting exports to domestic market^[9].

For commodity-linked sectors, the path to recovery depends on two key factors:
1. Policy Effectiveness: Can Beijing's anti-involution measures and fiscal stimulus meaningfully boost domestic demand without exacerbating deflation?
2. Global Demand Resilience: Will structural supply constraints in metals like copper offset China's waning appetite?

Conclusion: A Tactical Buy Signal?

The easing of deflation in late 2025 offers a cautious case for tactical entry into commodity-linked sectors, but with significant caveats. Sectors benefiting from government stimulus-such as green energy and infrastructure-present opportunities, while overcapacity-driven industries (e.g., steel, EVs) remain high-risk. Investors should prioritize flexibility, hedging against trade tensions and policy uncertainty. As Deutsche Bank notes, copper may see a structural rebound in H2 2025 due to supply constraints, but iron ore faces prolonged surplus risksCommodities outlook for 2025 prices – Deutsche Bank^[10].

In the end, China's deflationary cycle is not a binary event but a complex interplay of policy, market forces, and global dynamics. For now, the easing PPI and targeted interventions suggest a window for selective, well-informed bets-but patience and agility will remain paramount.