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China UpdateFrom Scotia. China Commodities Weekly for the Week of March 9-13, 2009 Macro – Exports Dropped, Investment Strong Fixed Asset Investment Strong
■ China’s fixed asset
investment in urban areas grew 26.5% year over year (YOY) in the first two
months of 2009. This is higher than the economists’consensus of 21.5% and
apparently a very strong data point. ■ Breakdown of the data shows
that the strong growth is heavily driven by government spending in the
infrastructure areas. Central government investment grew 40.3% YOY in
January-February 2009 compared with 29.6% in 2008. Particularly, investment in
the railways and transport sector grew 210.1% YOY. In contrast, private
investment remains abated. Investment in the real estate sector grew only 1%
YOY, down sharply from the 20.9% growth seen in 2008. Similarly, foreign
investment grew only 2.1% YOY, down sharply from 2008’s 15.8% growth. ■ As such, these data points
offer both good news and bad news. The good news is that the RMB4 trillion stimulus plan seems already to be working,
and public spending is on the rise in China. The bad news is that private
investment has been severely hurt by the economic downturn and shows no signs
of picking up yet. Overall, the data should be viewed positively – at least, public spending has successfully
filled the void left by sluggish private (and foreign) investment. That is
exactly what government spending should achieve in an economic recession. If
the U.S. government stimulus plan can eventually achieve the same effect, our
call on the global raw materials sector would be a lot easier. Unfortunately,
for the time being, we are seeing only China show some positive signs. IP Growth Dragged down by Exports ■ In February, China’s
exports dropped 25.7% YOY while imports dropped 24.1% YOY. As a result, China’s
trade surplus dropped to only US$4.84 billion in the month from US$39.11 billion
in December 2008. The sharp drop in exports shows clearly that consumers in the
rest of the world continue to tighten their belts. ■ In the first two months of
2009, China’s industrial production (IP) grew 3.8% YOY, lower than economists’
consensus of 6.4% and December’s 5.7%. Similarly, China’s retail sales grew
15.2% YOY versus economists’ consensus of 16.5% YOY. We observe that both IP and
retail sales should have performed better than the reported data implied. This
is because China reports IP and retail sales on a YOY basis, and at the beginning
of 2008, the Chinese economy was strong (and inflation was high) and offered a
high comparable statistical base. ■ Other than the statistical
base effects, the sharp drop in exports (down 25.7% YOY in February) also
dragged down the IP growth in the country. Monetary Policy Hugely Expansionary ■ Last week, China also
disclosed its February monetary data. M2 money supply grew 20.5% YOY
year-to-February versus economists’ consensus of 19.2%. This number shows that
the monetary policy is massively expansionary in China for the time being, as
it is much higherthan-expected real GDP growth (around 8%) plus inflation (in
the deflation territory in February). Also, as we already speculated in our
reports of the past two weeks, China’s loan growth in February remained
extremely high at RMB1.07 trillion (lower than RMB1.62 trillion in January, but
still the second highest on record). Overall Observations ■ Apparently, as exports slumped in the country,
China has sharply increased bank loans and fixed asset investment to shore up the economy. This bodes well
for a gradual rebound of IP growth going into the spring and the rest of the
year. ■ We also note that
electricity output, a closely watched macro indicator, fell 3.7% YOY in the first
two months, after shrinking 7.9% YOY in December 2008. Some observers took this
improvement as another positive sign. Macro – How “Wasteful” Is China’s Investment? ■ In his annual press
conference last week, Premier Wen Jiabao held out the prospect of extra stimulus
spending if needed to hit China’s 8% growth goal this year. On his economic
target of 8% GDP, Wen said: “I believe that there is indeed some difficulty in reaching
this target. But with strong effort it is possible.” ■ Responding to the market
disappointment of perceived failure to further enhance the RMB4 trillion
stimulus package, he said markets had failed to grasp that the government was already
providing relief over and above the stimulus: taxes would be cut by at least
RMB500 billion this year, pensions were going up and teachers’ salaries would
rise; further, RMB850 billion would be spent on China’s medicare reform over
three years. ■ What’s more, the government
had kept some powder dry in case the global economic crisis got even worse. “We have already
prepared plans to deal with greater difficulties, and have reserved adequate
ammunition. We can introduce new stimulus policies at any time,”
he said. “We now have more leeway to run a larger fiscal deficit and take on
more debt… The most direct, powerful, and effective way to deal with the
current financial crisis is to increase fiscal spending – the quicker the
better.” ■ We listened through Mr. Wen’s
press conference and found the following comments he made very insightful, and
we could not concur more. To refute the criticism of potential wasteful
investment in overcapacity areas, Mr. Wen said: “Every investment project under
the RMB4 trillion package has received a thorough feasibility study… And if you ever
visit China’s countryside, you will find no matter how much investment is made
in the rural area today, it is not really enough.” ■ Indeed, in recent client meetings,
we were repeatedly asked about our opinion on how much of the RMB4 trillion
investment would be “wasteful and useless” and how much would end up as bad
loans in the Chinese banks. To address our clients’ concerns, we have always made
two observations: ■ First, China’s
vast countryside is still very “backward” in infrastructure. Literally, China looks
like two countries. Big cities like Shanghai are as well built as Western
metropolises, but some rural areas of China still look like the poorest regions
in Africa. It is therefore very hard, at least by common sense, to argue that
infrastructure in the countryside to boost the rural economy is a waste. ■ And second,
although we do not think the investments would become massive bad debts for Chinese
banks, we argue that even if it does turn into bad debts, it would not be the
end of the China story. If Chinese banks were to bet in the stock markets like
the Thai banks before the Asian crisis, or bet in the property markets like the
American banks, we would be more concerned. This is because when the value of
the stock or property markets crashed, the investment turned into bad debts on
the banks’ books and it left nothing for the country. But if Chinese banks
invest in a rural road or a much needed railway or extend the electricity grid to
reach the poorest regions in China or help treat major cities’ water or air
pollution, even if these investments turned into bad debts eventually, the
country would be left with at least some infrastructure or some producing asset
or a little better environment. In essence, these investments are fiscal
spending in the name of commercial bank loans. ■ Ten years ago,
the Zhu Rongji administration, fighting against the Asian crisis, launched a massive
infrastructure campaign in China’s urban areas. Many of these investments
turned into bad loans for the Chinese banks. However, the infrastructure left
from these “bad loans” served as the foundation of China’s economic boom in the
past 10 years. Now, taking advantage of lower raw materials prices, the Wen
Jiabao administration is further extending the infrastructure by building into
China’s rural areas. This is an action that is easy to understand by common
sense, but quite hard to understand by analysts and economists minted by
Western MBA schools, who are often concerned by profit-oriented microeconomics
rather than the macro picture (that said, to their credit, these analysts did understand
and helped develop the complex, once profitable but now toxic assets owned by major
Western banks.) Commodities – Restocking Ahead of Demand ■ China disclosed
the production and trade data for key commodities last week. These data per se fit
our commodity calls very well: we like copper and iron ore, and we saw imports
of both reach record highs; we downgraded oil a few months ago and we have seen
oil imports collapse. ■ But the data
for iron ore and copper imports raised a concern. We have been making a call for
strength in China’s commodity demand due to a revival of construction activity
in the upcoming spring. Our problem is, Chinese traders and end-users have been
restocking commodities like iron ore, copper, steel, and oil in the winter
months, well ahead of the spring, when construction activity kicks off. Our concern is,
without the help of further restocking on top of organic demand growth, the
upcoming strength of China’s commodity demand might be smoother than what we
initially anticipated. As a result, our call for a tradable rally into spring
might prove less powerful, unless the equity market takes a correction here to
set a lower starting level. As one client
told us last week: “You have been calling for ‘buy-the-dip’. But where is the
dip? When the broad market dropped to new lows, major miners had held up at
levels nowhere near their November lows. And now the market is rallying and
materials stocks are going with it. Look at Freeport, it is now doubling its
November low. Real demand for copper, not only restocking, has to show up now
to justify the rally already taken place.” ■ With this
concern, in the rest of this section we examine key output and trade data for
some individual commodities. ■ Copper: China’s
refined copper production grew 10.9% YOY to 606,100 tonnes in the first two
months. On the trade side, China’s imports of unwrought copper and copper semis
rose 42% MOM in February to a record high of 329,311 tonnes. Although the
strong imports were partially attributable to the State Reserve Bureau (SRB)
purchase, there is some anecdotal evidence that shows real demand is also
picking up a bit. For instance, a source at fabricating plant Chinalco Luoyang
Copper said last week that large copper fabricators were operating at nearly
90% of capacity now versus 50% in late December. ■ As we wrote
last month, at US$1.75/lb or higher, the SRB is unlikely to book more purchases,
as its job is to buy the dip, not chase the momentum. Also, the Shanghai/LME two
weeks, indicating imports interest might drop from record levels. ■ Iron Ore: Similar to copper, China’s iron ore imports also rose 22.4% YOY and
43% MOM to a record high of 46.7 million tonnes in February. Domestic output
also grew 6.9% YOY to 105.43 million tonnes in the first two months of 2009.
The strong imports and output have already put pressure on spot pricing. Last
week, iron ore with 63.5% iron content was quoted at US$50/tonne FOB India,
down some 12% WOW and not far off the US$45/tonne seen at the end of October,
the lowest level last year. “More than the price levels, it is the inquiries that
have vanished in the last 15 to 20 days,” said a director of eastern
India-based Rungta Mines Ltd. Indeed, we heard a few stories of last-mintue
cancellations of Letters of Credit by Chinese buyers who no longer want to take
delivery of Indian ore. ■ We note that
the sharp drop in price and demand took place at a very critical time for the ongoing
annual contract negotiation and might negatively impact the settlement price.
We therefore now look for a 35% drop in the 2009 annual iron ore contract. ■ Steel: February’s steel products exports declined 18% from January to 1.56
million tonnes, a three-year low. “Who would source from China? Overseas demand
is weak due to the financial crisis, and Russian products are cheaper than
Chinese by US$50 to US$100 a tonne,” Wang Jing, who heads the trade department
of Baosteel, told Reuters in Beijing last week. In response to the price
disadvantage that has been preventing Chinese steelmakers from exporting, the
China Iron & Steel Association (CISA) has asked the central government to boost
export tax rebates. The official China Securities Journal reported last
Wednesday that the association had proposed raising the value-added tax rebate
for exported products including cold-rolled steel to 17% from 5%, and
reintroducing a 13% rebate on exported hot-rolled steel. ■ As we have
written in recent weeks, a recovery of output, which was up 3.1% YOY to 90.35 million
tonnes in the first two months, has pushed local steel inventories to high levels. The drop in
exports does not help digest the short-term glut in the market. ■ Coal: Similar to
steel, the Chinese coal market also faces higher output and lower exports. In the
first two months of 2009, China produced 368.91 million tonnes of coal, up 3.6%
YOY. Meanwhile, China’s coal exports slid to an 11-year low in February at only
1.44 million tonnes, down 52% YOY. In the meantime, China’s coal imports surged
to a 22-month high of 4.88 million tonnes (up 63% YOY) in February, as Chinese
power generators seek leverage in their term contract talks with major Chinese
coal miners. ■ As a result of
higher output and a net import of 3.44 million tonnes, the local Chinese coal market
is comfortably supplied going into its “shoulder season” of demand, when winter
heating demand is gone, but the heat waves of the summer, which drive air-conditioner use, still months
away. ■ Oil: China’s crude
oil imports fell by a steep 15% YOY in February, a second successive decline.
For the first two months, crude imports fell 13% to 24.55 million tonnes, the
biggest two-month decline since the start of 2005. As we previously flagged,
China’s oil inventory is high and strategic petroleum reserve (SPR) tanks are
now full. So the fall in imports may suggest that refiners – and the government
– have simply run out of room to store more oil. ■ Overall observations: In this section, we have raised a concern for the bull camp, to which we
belong: as China has been restocking over the winter, will the spring strength
of China’s commodity demand become less potent? Even with that concern,
however, we are still steadfast in our “overweight” recommendation and “buy any
major dip” call. To us, the bank loans in the past few months are just too
large to ignore – they will eventually translate into real construction
activity and physical raw materials demand. News In Brief Zinc – Concentrate Shortage? ■ China faces a
shortage of domestic zinc concentrates as a result of mine closures, according to
Huludao Zinc Industry Company. Zhang Jie, head of information at the company,
said that only about 30% of zinc mines in northern China are in production. Coking Coal – Lower Price Expectation ■ As the PCI coal price was
reportedly settled between Australian suppliers and POSCO at US$90/tonne last
week, we are now looking for the coking coal benchmark price to settle at US$125/tonne
(down from our previous forecast of US$130/tonne), given the normal relationship
between coking coal and PCI coal. We note that on the spot market, coking coal is
still sold to China at around the US$140-$150/tonne range. However, coke prices
have been under pressure in China lately, due to the pullback of steel prices. Grains – Slightly Lower Crop Expected ■ China’s wheat harvest will
likely slip 1.3% from last year’s bumper crop to 111 million tonnes after light
damage from the winter drought, while a 10% rise to 13 million tonnes in rapeseed
output may be partly offset by lower soybean planting, the government’s main grains
agency, the China National Grain and Oils Information Centre (CNGOIC), said in
its first forecasts for this year. Corn crop is expected to drop 2.5 million
tonnes from last year’s record 165.5 million tonnes. ■ We observe that CNGOIC
forecasts are very well respected. After years of failed efforts to decipher
China’s crop output and stock, for example, the USDA is now basically adopting the
CNGOIC numbers in its monthly grain report. The new CNGOIC forecasts support
our assessments that winter drought, billed as the worst in decades in China’s
major wheat areas, would do minimal harm. Also, it reaffirms our view that
China has sufficient supply for 2009, especially after the Chinese government’s
ongoing efforts to boost state reserves after last year’s record crop. Property – Prices Continued to Drop ■ The National Development
and Reform Commission (NDRC) said last Tuesday that property prices in 70 of
China’s large and medium-sized cities fell 1.2% YOY in February from a year
earlier, after declines of 0.9% in January and 0.4% in December. Prices of
newly built residential properties fell 1.8% in February, steeper than the 1.4%
fall in January. Highend residential property prices fell 2.8%, extending
January’s 2.0% fall. The decline was also worse than the 1.8% drop in regular
residential properties. ■ Prices of low-end
residential units rose 0.3% YOY, the NDRC said. Since October, the Chinese
government has been giving tax breaks targeting first-time buyers of
lower-priced properties, and also encouraging banks to grant them preferential
loans. ■ Secondary-market prices in
February fell 0.7% YOY, after January’s 0.3% decline. Auto – Vehicle Sales up 24% YOY in February ■ China’s total vehicle sales
rose 24.72% YOY to 827,600 units in February. Although the YOY comparison was
likely inflated by the low statistical base in February 2008 due to Spring
Festival and snowstorms, the Chinese auto market performance is still very
strong compared to the rest of the world. Economy – Deflation, at Least by Statistics ■ In February, China’s CPI
dropped 1% YOY and PPI declined 4.5% YOY. Therefore, at least statistically,
the Chinese economy has entered a deflationary phase. In reality, however, these
numbers are hardly surprising, as China reports CPI and PPI on a YOY basis, and
in February 2008, China experienced peak inflation due to then-high-flying food
and raw materials prices. Economy – Wen’s Comments on China’s
Investment in U.S. Assets ■ On China’s investment in
U.S. assets, Premier Wen Jiabao said in his annual press conference: “We have
lent a massive amount of capital to the United States, and of course we are
concerned about the security of our assets. To speak truthfully, I do indeed
have some worries. I would like to once again request America to maintain their
creditworthiness, honour their commitments, and guarantee the safety of Chinese
assets”. ■ Wen did indicate that China
would not be rash in making changes to its US$1.946 trillion stockpile of
foreign reserves, much of which is in U.S. dollars. While China is naturally looking
out for its own interests, it will “at the same time also take international
financial stability into consideration, because the two are interrelated,” he
said. Recap of Our Calls ■ Essentially, we are making
four calls in our China Commodities Weekly: economic trends in China, our
overall sector call, our individual commodity sector views, and our calls for
the contract negotiations for certain commodities. We recap our calls as
follows: ■ Economic trends:
There are three intertwined trends for the Chinese economy – seasonal (the
current and next few months), cyclical (the current and next few years), and
secular (the current and next few decades). We are currently a seasonal bull, a
cyclical bear, and a secular bull. ■ Overall sector call:
Our overall sector call is to answer one question: purely from a China perspective,
should investors in the Western world be overweight, market weight, or underweight
in the global raw materials and energy sectors? To this question, our current answer
is overweight. ■ Individual commodity sectors:
On individual commodity sectors, we are now positive on the copper, steel, iron
ore, uranium, urea, DAP, methanol, and hardwood pulp sectors. We are neutral on
aluminum, zinc, nickel, molybdenum, coking coal, thermal coal, potash, wheat,
corn, soybean, ethylene, and crude oil. We are cautious on paper products.
Please note that our positive, neutral, or cautious views on individual
commodity sectors are all on a relative basis from a China perspective. ■ Views on annual contract negotiations: We now look for a 35% drop in the 2009 annual iron ore contract. We expect the coking coal 2009 contract price to drop to US$125/tonne. We expect the potash 2009 China contract to increase by US$24/tonne to US$600/tonne. |
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Msg # | Subject | Author | Recs | Date Posted |
59598 | Re: China Update | Scam | 0 | 3/18/2009 5:27:23 AM |