I just left Saigon, in Mui Ne. Please excuse the formatting if everything mess up.

The following was published on October 23.
Angkor was great. Sihanoukville has fine sandy beaches and clean water. Cambodia and Vietnam weathers are a few degrees cooler than Singapore and Indonesia. Mandalay Inn in Sien Reap, and Han Chau Hotel in Chao Doc were very clean and very good value for the price of $10 per night.
The world goes on, with all the recession talks in US. The tourists here come from everywhere, Europe, UK, US, Australia, Taiwan, Hong Kong, etc.

China Update
China Commodities Weekly for the Weeks of October 19-23, 2009
Macro – Recovery Now “Consolidated”
■ Overnight, China released its Q3/09 and September macroeconomic data. All growth data are in line with economists’ consensus. The Chinese economy grew 8.9% YOY in Q3/09, the fastest pace in a year (consensus 8.9%); industrial production climbed 13.9% YOY in September (consensus 13.2%); fixed asset investment rose 33.3% YOY in the first nine months of 2009 (consensus 33.1%), and retail sales jumped 15.5% in September (consensus 15.5%).
■ Although the data were only released last night, their policy implications were made clear the day before. After a meeting chaired by Premier Wen on October 21, the State Council (China’s cabinet) issued a statement saying that the Chinese economy had performed more strongly than expected in the first nine months of the year, and more importantly, the economic recovery has been “consolidated.” This new official assessment marks a clear shift in rhetoric after months of insisting that the Chinese economy was not yet back on solid footing.
■ Going forward, the State Council said that it will balance the relationship among maintaining relatively fast economic growth, adjusting the economic structure, and “managing inflation expectations.” Although the cabinet statement reiterated that it will maintain its “proactive fiscal policy and moderately loose monetary policy,” we note that this is first time that “managing inflation expectations” hit headlines in the domestic press. As such, we now believe that Chinese CPI and PPI should be monitored closely. Although both CPI and PPI are now in negative territory, down 0.8% and 7% YOY, respectively, in September, monetary policy might become less easy when headline inflation data turn positive in the next few months.
■ In fact, in our opinion the rhetoric change by the State Council marks the first step towards normalizing monetary policies. We do not expect an imminent hike in interest rates or the reserve ratio; however, we do see the Chinese authorities gradually tightening bank lending rules to curb loan growth. We note that the country’s banking regulator, the China Banking Regulatory Commission (CBRC), has been very vocal in recent days. It has urged Chinese banks to control their Q4 lending to “reasonable” levels, to strengthen credit risk controls, and, more importantly, to brace for any potential policy shift. CBRC Chairman Liu Mingkang said during a teleconference with lenders across the country that banks ought to “closely monitor possible repercussions on market liquidity caused by global capital flows, macroeconomic trend changes, or policy adjustment, always keep sufficient liquidity, and set reasonable maturities on loans.”
■ Past experience in both China and the Western economies shows that when monetary policy just begins to normalize/tighten, cyclical sectors such as raw materials and energy tend to continue to outperform the broad market. This is because the beginning of a tightening cycle indicates that monetary authorities now believe economic growth is strengthening and inflation risk is on the rise. Better economic growth prospects and higher inflation expectations are the two key drivers for the commodities bull market. Therefore, the mere fact that the Chinese authorities are normalizing China’s monetary bias is not a cause for concern, in our opinion; it is in fact arguably a cause for celebration for the bulls – the recovery is now “consolidated,” at least according to the Chinese government.
■ That said, the bears might argue that “this time is different.” Indeed, if this economic recovery in China has been mainly driven by government stimulus and huge bank loans, the legitimate question is what will happen when the stimulus wears off and loan growth slows down. For instance, a Bloomberg story published on October 21 was entitled “China’s ‘Growth on Steroids’ Risks Next Slowdown.” According to some views cited in the article, the Chinese recovery “has been growth on steroids… The question now is how to stop pumping so much money into the system without a sharp reduction in growth…. State directed support will make up more than four-fifths of growth this year, says the World Bank.” To answer these concerns, we would like to point out, once again, that it looks increasingly likely that home sales, as a key consumption driver, and home construction, as a key investment driver, will fill the void left by the phasing-out of government stimulus and excessive bank loans (see next section).
■ As to major commodities output data, our concerns about supply-side response are once again confirmed. In September, China’s refined copper output grew 20.5% YOY and 8.2% MOM to a new record of 394,800 tonnes; aluminum output increased 5.6% YOY and 7.6% MOM to a record 1.207 million tonnes; refined nickel output jumped 47.7% YOY and 8.3% MOM to 20,419 tonnes; and refined zinc output grew 19.2% YOY but dropped 1.1% MOM to 410,300 tonnes. On the bulk side, raw coal output grew 12.7% YOY and 0.9% MOM to 263.16 million tonnes; iron ore output jumped 26.2% YOY and 11.4% MOM to an all-time high of 85.43 million tonnes; and crude steel output grew 28.7% YOY but dropped 3.1% MOM to 50.711 million tonnes. On the oil side, the September crude run increased 14% YOY to a new record of 32.83 million tonnes.
Macro – Strong Home Construction
■ Last week, the National Bureau of Statistics released the September data for China’s real estate market. The data feature a slowdown in home sales growth and further strength in home construction growth. This is exactly what we had predicted in our recent publications.
■ National property sales grew 56.3% YOY in September to 89.55 million square metres. The growth was lower than August’s 85% and July’s 67.7%. The absolute sales data remained lofty and were driven by strong sales in second-tier cities.
■ National construction grew 66.5% YOY to 146 million square metres. The growth is much higher than August’s 40.1% and July’s 7.4%. In fact, this is the first time since March that construction growth overtook sales growth.
■ As to key leading indicators, land acquisitions rose 8% YOY in September, representing the first positive YOY growth this year. Land development grew 30.4% YOY last month, up from 21.8% seen in August. New home starts climbed 56.89% YOY September, also sharply higher than August’s 23.66%.
■ In terms of price, Chinese property prices in 70 cities rose 2.8% YOY in September. This was the fourth consecutive YOY rise after seven months of declines. Compared with August, prices rose 0.7% in September, building on a 0.9% gain the month before.
■ Overall, we like the data we saw, and the data confirm our view that developers in China have finished de-stocking and have begun a construction boom to replenish inventory. As we wrote at the end of our macro discussion in our report last week: “Government-supported infrastructure construction has been the key driver of Chinese raw materials demand so far this year. Ideally, if home construction can pick up strongly after months of strong home sales, Chinese raw materials demand will then have a second leg. This is why we have refused to change our overweight call for the raw materials sectors despite high commodity inventories and sluggish spot market prices in China.”
Methanol – The Blending Myth
■ In early October, a few clients attended a “methanol forum” put on by one of our competitors. Some speakers seemed to be talking up a Chinese methanol story with respect to a “massive increase in blending efforts.”
■ This should be nothing new for our readers. Back on May 29, 2009, we wrote: “On May 21, the Standardization Administration of the People’s Republic of China has approved its National Industry Standard for Fuel Methanol for Motor Vehicles (Standard No. GB/T 23510-2009). The standard, which becomes effective November 1, 2009, stipulates the specification, testing methods, inspection rules, and the packing, transportation, storage, and safety requirements of fuel methanol for motor vehicles. The standard has been hailed by local industry participants as the legal foundation that will transform methanol from a mainly chemical product for industrial use to a fuel product for motor vehicle use.”
■ As November 1, 2009, is quickly approaching, will we observe a sudden surge of methanol use? The answer is no, at least in the near term. Standard No. GB/T 23510-2009 is a national standard for fuel methanol for motor vehicles, which means that methanol meeting the standard can be legally blended into gasoline. However, the methanol-blended gasoline, the end product of the blending, still needs separate standards. Although methanol can be blended into gasoline at any percentage, there are two major types of methanol-blended gasoline, M15 and M85. M15 means that the gasoline contains 15% methanol, while M85 means that the gasoline contains 85% methanol. For the blending practice to roll out across China, a national standard for M15 and M85 is needed, particularly for M15. It is widely believed in China that M85, given its high methanol content, will require a modification of vehicle engines, while M15 does not require that and can be readily used by regular cars.
■ On July 2, 2009, the Standardization Administration approved the national standard for M85 (Standard No. GB/T 23799-2009). The standard will be effective on December 1, 2009. The approval of M85 standard is a meaningful step for the nationwide rollout of methanol blending, but as M85 requires engine modification, its impact will not likely be felt immediately.
■ On July 21, 2009, the official newspaper China Securities reported that the national standard for M15 will likely be approved before the end of this year. As M15 does not require engine modification, its approval will greatly improve the prospect of the national rollout of methanol blending in China.
■ Even if the M15 standard is approved, the rollout will still be a gradual process, as it requires the cooperation of the duopoly of PetroChina and Sinopec, which controls the majority of Chinese gasoline stations. As PetroChina and Sinopec do not produce methanol themselves, their attitude towards the blending practice is questionable. Given that China has gasoline consumption of about 60 million tonnes, if M15 fully rolls out, it will compromise 9 million tonnes of gasoline sales by the duopoly.
■ In summary, we do consider the approval of a national standard of fuel methanol and M85 positive development for the methanol sector in the medium term. However, to achieve the national rollout of the blending practice, the M15 standard still needs to be approved, and Sinopec’s and PetroChina’s cooperation needs to be gained. Therefore, we believe blending demands for methanol will only increase gradually. Moreover, in the past few years, methanol has been openly blended into gasoline (and, to a lesser extent, diesel) in Shanxi Province, Shaanxi Province, and Inner Mongolia anyway. We estimate that last year, at least 2.5 million tonnes of methanol were blended into gasoline in these three provinces, although this practice has never been formally legalized by the central government. For the time
being, on an annualized basis, 4 million tonnes of methanol are blended into motor fuels in China. (In Shanxi Province, M15 is readily available in many gas stations. It is well accepted by some users such as taxi drivers, but most private car owners still refrain from using it.)
■ In the longer term, as China is “short oil” but “long coal,” methanol blending is a legitimate partial solution to China’s fuel needs. For the time being, 50% of China’s crude demands are already relying on imports. To address the fuel shortage, corn-based ethanol is not the solution for China, due to the lack of arable land and grain security issues. This leaves coalbased methanol a feasible choice.
■ This is why, eventually, we believe methanol will be traded more like fuel rather than a chemical product. The price trend for gasoline will likely eventually become the most decisive factor that determines methanol pricing in China. Even for today, the math for direct blending is simple: 1 tonne of methanol is now traded around RMB2,000/tonne, but gasoline is traded at over RMB6,500/tonne. (On an energy-equivalent basis, 1.6-1.8 tonnes of methanol equal 1 tonne of gasoline.)
News in Brief
Copper – Physical Premium Up
■ There are signs that copper demand in the physical market is turning better. Physical copper premiums firmed up to about US$60/tonne above the LME in Asia, up from US$40-US$50/tonne at the end of September. Traders said that things are recovering after the October holidays and Chinese buying has picked up from pre-holiday levels.
Iron Ore – Tough Negotiations Ahead
■ Vale of Brazil, Rio Tinto, and BHP Billiton will ask for a 30%-35% increase in iron ore prices for 2010-11, partially reversing the 33% cut agreed for 2009-10, the Financial Times reported on October 14, 2009. They will also ask for a 40%-50% rise in coking coal prices, after a 58% fall this year.
■ In contrast, the China Iron and Steel Association, the body that last year led the Chinese negotiations, has sent clear signals that it wants a price cut. Luo Bingsheng, CISA vicechairman, said last week that the oversupply left no room for price increases. CISA Secretary General Shan Shanghua was also quoted as saying: “we will not insist on other countries taking China’s iron ore prices as a reference and we will not blindly accept prices agreed to by other countries.”
Steel – Output Rose in Early October
■ The latest CISA figures showed daily crude steel output rose to 1.692 million tonnes in the first 10 days of October, up from 1.646 million tonnes in the last 10 days of September and 1.655 million tonnes in mid-September, within a whisker of the record 1.693 million tonne average seen in late August. Early October’s production was equivalent to annual output of 618 million tonnes, compared with 500 million tonnes in 2008.
Urea – A Small Price Rebound
■ After the October holiday, the Chinese urea market registered a small rebound. Average national retail prices rose some RMB15/tonne to about RMB1,618/tonne. We note that the rebound is driven mainly by higher coal costs. In September, delivered coal prices to Chinese urea plants rose some RMB30/tonne. Some urea plants are reporting coal shortages. As average ex-plant urea prices are in the range of RMB1,500-RMB1,600/tonne, urea plants relying on coal from the open market are now facing financial losses and are forced to raise ex-plant prices.
Grains – Output Down No More Than 4% in Northeast
■ The three provinces of Heilongjiang, Jilin, and Liaoning are about to harvest at least 85.5 million tonnes of grain, compared with 89.3 million tonnes in 2008, said Zhang Guobao, the deputy head of the National Development and Reform Commission. “Despite a severe drought this year in the northeast, grain output there would still be at a comparatively high level,” Zhang said at a news conference. He did not give any breakdowns.
■ The three provinces, with grain output accounting for 17% of the country’s total harvest last year, together make up China’s largest grain-producing region. China was expecting a bumper harvest, the sixth year in a row, despite a drought earlier in the year in wheat areas in the central part and later on in the northeast area.
Potash – Negotiation “At Final Stage”
■ BPC said last Friday: “Talks with China are at a final stage right now. We plan to sign the contract by the end of October or in November. We hope to keep supplies at 2008 level. This is about 860,000 tonnes.”
■ We heard that Chinese buyers are seeking a contract price for 2010 at around US$360/tonne, which is in line with local market prices. That is about S$335/tonne FOB. We note that this is only bid level. The ask level by BPC should be a lot higher, as indicated by the recent Vietnam sales (at US$500/tonne delivered). This is why, if there is a deal, we look for US$395/tonne FOB for China, which is about US$40/tonne lower than India’s US$460/tonne C&F.
Oil – Ensuring Refining Capacity
■ Chinese authorities have quietly endorsed new plans to increase domestic refining capacity by 40% by 2015, focusing on the expansion of existing sites rather than building new plants,
industry sources said on Tuesday.
■ The target to reach 11 million barrels per day (bpd) capacity – enough to ensure China remains self-sufficient in refined fuels as long as demand grows at a rate of around 5%-6% – is an extension to an industry “revitalization plan” announced in May that set a goal of 8.8 million bpd by 2011.
■ The guidelines, compiled by China Petroleum and Chemical Industry Association (CPCIA) and major state oil companies, have recently been endorsed by the central government, according to an industry official familiar with the plan.
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 eight, or underweight in the global raw materials and energy sectors as a whole? 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, coking coal, uranium, molybdenum, corn, DAP, and hardwood pulp sectors. We are neutral on aluminum, zinc, nickel, thermal coal, potash, urea, wheat, soybean, methanol, 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 are looking for a 7.5% rise in the 2010 annual iron ore contract. We expect the 2010 benchmark Australian hard coking coal price to settle at US$160/tonne, up from US$129/tonne in 2009. We expect the 2010 China potash contract price to drop US$181/tonne from its 2008 level to US$395/tonne FOB.