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Msg  59157 of 65647  at  1/21/2009 12:48:00 PM  by


China Update

Published yesterday by Scotia Capital.

China Commodities Weekly for the Week of January 12-16, 2009

Last week, China’s base metals, steel, and iron ore markets were down slightly, except for zinc and rebar. Grain prices were largely higher, supported by the government’s reserve purchase plan. Fertilizer retail prices continued to drop. Ethylene and methanol prices were both higher. As for energy, oil product prices dropped, but coal prices were stable.

In this report, on the macro front, we discuss the surge of China's loan growth in December and its implications for our “buy the dip” call. We also take a look at China’s surging purchase of U.S. treasuries. On the commodities side, we examine China's export economics for urea, amid speculation over a change in urea export taxes. We also discuss the recent price direction for coke and coking coal, both within and outside the Chinese market.

Macro – Strong December Imports and Loan Growth

Strong Imports for Key Commodities

Last week, China released preliminary trade data for key commodities. The data shows strong import growth in December 2008. In the month, China’s copper imports, including semis, were up 32% MOM to 286,576 tonnes; iron ore imports climbed 6.2% MOM to 34.53 million tonnes; crude oil imports grew 11.6% YOY and 4% MOM to 3.38 million bpd; net refined oil products imports soared 145.5% MOM and 12.5% YOY; and soybean imports increased 12.8% YOY to 3.3 million tonnes.

We observe that the strong imports of key commodities in December coincide with other positive developments we discussed in detail last week – the price rebound and inventory drawdown of steel, iron ore, and coal in the local market. These market dynamics continue to support our “buy the dip”call on the global raw materials sectors.

That being said, if investors “choose” to see the bearish side of the strong import data, they can raise a very legitimate question: if China is still importing and we still get US$1.40/lb copper and US$40/barrel oil, what would happen if China stops buying? At the very least, strong Chinese purchases of copper did not save the copper market, for example.

On the export side, in December 2008 China’s finished steel products exports rose 7% MOM to 3.17 million tonnes; coal exports jumped 66% MOM to 4.47 million tonnes; and unwrought aluminum exports rocketed 155% MOM from a dismal November.

A Spike in Loan Additions

More encouraging than the strong imports data are the very robust loan additions in December. In the month, Chinese banks issued RMB771.7 billion of new yuan loans, compared with RMB476.9 billion in November 2008 and RMB48.5 billion in December 2007. M2 money supply rebounded to 17.8% year-to-December, compared with 14.8% year-to-November.

Last October, when the Chinese central bank took notice of the deteriorating economic situation, it scrapped the loan quota system. Essentially, since November, commercial banks in China were allowed to lend as much as they wanted, without a quota cap. As a result, we saw China’s loan additions rebounding sharply into November and December (see Exhibit 1). This is very encouraging, as loan additions are the main fuel for China’s economic growth. In contrast to Western banks, Chinese banks are still lending, and are actually accelerating lending. This means that the government is not having any trouble in getting financing for its massive fiscal projects.

Today’s lending translates into construction/manufacturing activities about three months later. Therefore, the strong loan additions at the end of 2008 bode well for a spring revival of economic activities in March-April 2009, when migrating workers come back from their rural families to the urban areas after the Spring Festival.

Winter Lull to Be Followed by a Spring Revival

To summarize our recent views, we believe investors should continue to buy the dip in the global raw materials sectors, but should not chase upside momentum, if any, too aggressively before mid-February.

Why not chase upside momentum? For three reasons: (1) real demand for key commodities has not recovered yet (the Sichuan earthquake rebuilding being an exception); (2) the Spring Festival is coming and it represents weak seasonality for construction activities; and (3) Q4/08 GDP and December macroeconomic data, to be announced later this week, are likely to be weak.

Why continue to buy the dip? Also for three reasons: (1) strong loan growth indicates demand will come, eventually; (2) more stimulation is to be announced, according to Premier Wen last week; and (3) March and April have strong seasonality for construction/manufacturing activities. When the money is ready (loan additions are strong), the projects are ready (a lot of government-sponsored projects have been approved), and labour is ready (migrating workers come back to the cities), a typical spring revival in March and April looks highly likely.

We note that our view about a March-April “spring revival” is not a consensus view. Most economists are looking for a rebound in Chinese economic activities in 2H/09, not Q2/09. In contrast, we believe seasonal economic strength might well come in the spring in China. Of course, investors should always balance our view on China against their own views on the rest of the world. Even though we are comfortable that China will show strength in the spring, whether or not it is sufficient to offset the slackness in the rest of the world is a question that is beyond our ability to answer. (As we have written above, even though China’s copper imports have remained very strong in 2H/08, it did not prevent the copper price crash on the LME).

Macro – A Big Buyer of U.S. Treasuries

In November 2008, foreign investors dumped a record US$56 billion in long-term U.S. securities (US$4 billion in stock purchases offset by US$60 billion bond sales), following an upwardly revised net sale of US$36.6 billion in October. Among bonds, the net sale of longterm U.S. treasuries was seen for the first time since August 2007, when the credit crisis erupted, and was done all by official institutions.

That said, China, the largest holder of treasuries, actually increased its holdings of U.S. treasuries by US$29 billion to a record US$681.9 billion. This fact shows that China has been very “cooperative” in supporting efforts to bail out the U.S. financial system. It also shows that the fear that China might dump U.S. treasuries to either “diversify” or to “fund”its domestic fiscal expenditures had not materialized, at least up to last November.

Exhibit 2 shows that China has been aggressively buying U.S. treasuries. In addition, China’s holdings in U.S. treasuries as a percentage of its foreign exchange reserve is also on the climb. We understand that some observers believe that China’s increased purchase of treasuries merely represents a shift from U.S. agency debt holdings to treasuries.

With such a high level of holdings, does the Chinese central bank feel nervous? To this question, we really do not know the answer. If one wants to identify some “warning signs,” one can observe that in November, China’s net holdings of longterm treasuries fell by more than US$9 billion, while its short-term holdings rose by US$38.2 billion. “The creditor is giving up yield to give itself the option of exiting quickly,” wrote a fellow at the Council on Foreign Relations.

Urea – Export Economics

As we wrote last week, producers and traders in China are still awaiting further news on possible changes to the urea export tax starting February 1. The current off-season tax rate of 10% is due to end January 31, and from February to July, the export tax was initially scheduled to be enforced at 110%, consisting of a 75% special tax and a 35% base export tariff. Chinese urea producers have been aggressively pushing for a complete removal of the export tax in recent weeks. We believe that there is a 30% chance that the 75% special tax will be removed, making the effective export tax rate 35% starting February 1. (Our expectation for China’s urea export tax in February is: a 60% chance of enforcement at 110%; a 30% chance at 35%; and a 10% chance of it remaining at 10%.)

For the time being, mainstream export prices are at US$270-US$290/tonne FOB Chinese ports. Domestic prices are at around RMB1,650/tonne, implying a minimum return at US$265/tonne to break even with a 10% export tax. Local anthracite coal prices recently rebounded, supportive of local prices from a cost perspective.

With benchmark U.S. New Orleans urea prices now having rebounded to US$300/st, due to the Russia-Ukraine disputes on natural gas supply, it is clear to us that at a 110% export tax, China will not be able to export at all. At a 35% export tax, Chinese producers would require a minimum US$325/tonne to make the export business profitable. With a 10% export tax, Chinese exports would continue, but not on a large scale.

Coking Coal – A Bit of Clarity

In the Chinese domestic market, coking coal prices have climbed from lows seen in late November by some 20%. Domestic coke prices also rebounded sharply. In Shanghai, the spot price for #2 Grade Coke has climbed from its low of RMB1,400/tonne in late November to RMB1,900/tonne last week.

On the export market, Chinese coke is now quoted at US$350/tonne, up from its low of US$300/tonne at the end of November (Exhibit 3). On April 7, 2008, when BHP

and Posco concluded the US$300/tonne deal for coking coal, the export price for Chinese coke was US$565/tonne. A drop of US$215/tonne in coke prices implies a drop of US$150/tonne in coking coal prices. From this perspective, the most recent Chinese coke export price indicates a coking coal 2009 contract price at US$150/tonne.

Outside China, we understand that Australian producers have reportedly offered

prices of US$140/tonne for hard coking coal to Asian buyers for the 2009 contract, while Japanese buyers are seeking a price back to the 2007 level (US$98/tonne). We also understand that Russian miner Belon is offering coking coal at US$100/tonne to Asian customers (and US$68/tonne to domestic users). On the spot market, most reports indicate recent spot deals in the US$120-US$140/tonne range.

Given the above information, we maintain our view that the 2009 coking coal benchmark contract price will drop to US$130/tonne.

News in Brief

Copper – “Chinese the Only Buyers”

Jerrold Annett, our metals sales specialist, made the following comments last Friday: “A call this morning to my main industry contact who sells about 5% of world cathode supply tells me the Chinese are the only buyers right now. He is becoming frustrated with the outright lack of interest from the rest of the world. Any buying in Europe and the U.S.A. (collectively account for about 45% of world demand) is done through spot purchases and through various traders but not via producers direct. This demonstrates the diverging interests between cathode end-users and cathode producers. Eventually, cathode producers sitting with high levels of unsold inventory will need to sell to the LME/Comex warehouses. We havent seen the worst. China is the only buyer right now but this will likely stop as they are simply stocking up ahead of the Chinese New Year … by the end of January, we will start to see some big inventory increases and prices are likely to fall.”

Copper – TC/RC to Be Up 60%

Chinese copper smelters are expected to settle term treatment and refining charges (TC/RC) for 2009 very soon at US$75/tonne and 7.5 cents a pound with BHP, according to industry sources. This represents a rise of nearly 60% over 2008. A similar deal had already been made with Freeport.

Copper – Jiangxi Copper Sees Low Demand Growth in 2009

China’s refined copper consumption will rise about 2% in 2009, Wang Chiwei, executive director at Jiangxi Copper, said yesterday.

Copper – SRB to Buy from Abroad

“The State Reserve Bureau has a lot of ways to purchase copper and probably it will purchase on the international market because domestic copper smelters have limited stockpiles for the government to buy. If we delivered the copper to SRB, we might have to break contracts with our customers,” said Wang Chiwei from Jiangxi Copper.

Zinc – SRB Bought Small Amount

China’s State Reserve Bureau bought 59,000 tonnes of zinc from seven state smelters last Wednesday at RMB11,800 (US$1,726) per tonne, 3.5% higher than spot prices in Shanghai on the same day. The agreed volume was lower than an expected 100,000-200,000 tonnes because smelters considered the price too low.

Nickel – Nickel Ore Stock Down

China’s laterite ores at discharging ports are being consumed quickly over the most recent month. On January 8, 2009, the total stockpile was 7.9 million tonnes at all ports, decreasing by 600,000 tonnes from December 2008, according to Antaike.

Chinese low-grade nickel pig iron producers started to resume partial production in November 2008, due to lower coke prices and better realization of Fe credits. Currently, about 10 enterprises using blast furnaces operated at full capacity in Shandong province.

Steel – Baosteel Raises March Prices After February Hike

Baosteel raised its sales prices for major hot-rolled and cold-rolled steel products for March by RMB300/tonne from February levels.

Steel – China Will Control Steelmaking Capacity

China will strictly control total steelmaking capacity and will not allow any new steel capacity expansion projects, China’s State Council said on Wednesday. The China Iron and Steel Association estimates the total capacity at 616 million tonnes at the end of 2008, up from 550 million tonnes at the end of 2007. The association estimates that in 2008, China produced 500 million tonnes of steel, up only 2% YOY.

Steel – China Wants to “Stabilize” Its Market Share for Steel Exports

The State Council also said it would adopt a flexible tax policy on steel exports to stabilize China’s share of the global steel market.

Iron Ore – Atlas Saw Iron Ore Demands Strong

Australia’s newest iron ore miner, Atlas Iron, said last Thursday its expansion plans remained supported by demand from China, although steel mills are pushing for a 40% cut in contract prices for 2009.

“There’s something of a chasm out there – there’s a huge disconnect between the financial pages and what my marketing team is hearing. We’ve got 10 keen expressions of interest yesterday from people wanting to buy iron ore,” Atlas Chief Executive David Flanagan said.

Project funding was not a problem, according to Flanagan, who said China’s steel groups stood ready to become project partners and sign long-term off-take agreements. “The money is coming at us thick and fast … China wants alternatives,” he said.

Potash – Mosaic’s View on the Negotiation

During Mosaic’s Analyst Day on January 13, the company said China could potentially take six months to strike a deal with international potash suppliers. China has carryover stocks from last year, but not enough to get through the calendar year, according to Mosaic.

Grain – China Will Raise Grain Procurement Prices

China may raise the minimum prices for grain “more than expected” this year to help stem a widening income gap between urban and rural areas, local media reported.

Coal – Still a Net Exporter in 2008

In 2008, China registered a net export position for coal of 5 million tonnes. Imports fell 21%, to 40.4 million tonnes in the year, while exports dropped 15%, to 45.43 million tonnes.

Coal – Output Grew 7.7% in 2008

China’s coal output climbed 7.7% YOY in 2008 to 2.7 billion tonnes, according to the China Coal Industry Association.

Oil – Product Prices Trimmed by a Few Percent

The National Development and Reform Commission (NDRC) reduced the ex-factory price of gasoline and diesel starting from midnight on January 15. The price of #90 gasoline will be reduced by 2.5% from RMB 5,580/tonne to RMB 5,440/tonne, whereas the price of #0 diesel will be reduced by 3.2% from RMB 4,970/tonne to RMB 4,810/tonne. Maximum retail prices will be reduced by the same magnitudes.

After the cut, Chinese consumers are still paying massively higher prices than American consumers. The NDRC said after the cut that it will not adjust fuel prices too frequently.

Oil – IEA Sees Only 1.1% Demand Growth in 2009

China’s oil demand is likely to rise a mere 1.1% in 2009, compared with estimated growth of 4.2% in 2008, according to the IEA. The growth would be only 90,000 bpd in 2009, the slowest since 2001.

Auto – China Unveils Plans to Boost Auto Industry

China unveiled a wide-ranging plan, including tax cuts and subsidies last Wednesday to boost its auto industry.

The State Council said it would cut in half, to 5%, the sales tax on purchases of cars with engine sizes below 1.6 litres. The government will also give one-off cash subsidies totaling RMB5 billion to owners of high-emission vehicles who trade them in for more fuel-efficient, cleaner ones. It will also set up a RMB10 billion fund to promote new technology, including renewable energy, over the next three years, while supporting the eventual mass production of electric vehicles.

The auto sector has been hit hard by waning consumer confidence, with growth in sales of passenger cars slowing to 7.3% in 2008, the first year of single-digit growth in over a decade.

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 negotiation 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 bear, 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 overweight, market-weight, or underweight the global raw materials and energy sectors? To this question, our current answer is “overweight,” despite the fact that we are both a seasonal and a cyclical bear for the time being. In our opinion, the raw materials sectors have sold off so severely to a level where the secular bullish trend should offer a strong support.

Individual Commodity Sectors: On individual commodity sectors, we are now positive on the oil, copper, steel, uranium, potash, DAP, and hardwood pulp sectors. We are neutral on aluminum, zinc, nickel, molybdenum, iron ore, coking coal, thermal coal, urea, wheat, corn, soybean, methanol, and ethylene. 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. More importantly, our views on a sector are not purely based on near-term price direction for the underlying commodity. We are positive on a commodity sector if we believe the equity market is discounting an unsustainably low commodity price.

Views on Annual Contract Negotiations: We are now looking for a 30% drop in the 2009 annual iron ore contract. We expect the 2009 coking coal contract price to drop to US$130/tonne. We expect China’s 2009 potash contract to increase by US$24/tonne, to US$600/tonne.

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