China Commodities Weekly for
the Week of January 19-23, 2009
■ Last week,
ahead of the Chinese New Year, the Chinese domestic markets were very quiet.
■ In this report,
on the macro front, we discuss China’s macroeconomic data for Q4/08 and
December 2008 and explain how to take advantage of the potential “spring
revival” in China when the rest of the world is still in deep recession. We
have also upgraded our view on iron ore to “positive” from “neutral.”
Happy Chinese New Year
■ First of all, please allow us to wish our readers a
happy, healthy, and prosperous Chinese New Year!
■ Today is the start of the Year of the Ox in China.
Note that this is the Year of the Ox, not the Year of the Bull. Based on this
author’s limited knowledge of English vocabulary, “cattle” seems to be the
generic term for those domesticated bovines that we associate as oxen, bulls,
and cows. Of these, oxen are those used as draught animals (i.e., used to pull
ploughs and wagons on a farm). Bulls are, of course, non-castrated male cattle
that are kept for breeding, while castrated ones are called steers and are,
generally, destined for the dinner plate. Cows are female cattle that have
borne calves, and those that have not done so are called heifers.
■ According to Chinese feng shui, which we do not
believe in at all, the Chinese New Year which starts today is not only the Year
of the Ox, but also an “earth” year. In Chinese geomancy, everything in the
universe is composed of the five elements — wood, fire, earth, metal, and
water. How these elements interact with each other creates a cycle of creation
■ While the five elements interact with each other in
a cycle of creation or destruction, they also have a standalone meaning in how
they affect one’s temperament. Fire represents burning passions such as
irrational exuberance, and is also the main driver of the stock markets. Water
represents fear and is the principal element constraining fire. Earth, on the
other hand, represents calmness and meditation, while metal stands for sadness
and wood is anger. Last year having been a “Brown Earth Rat Year,” the absence
of fire and the fact that the rat represents water (which douses fire) could
explain the worsening market and economy, according to the feng shui view from
Bank of China International.
■ This year will
be a “Brown Earth Ox Year.” Ox is of the nature of earth, so it is a double earth
year. As earth absorbs water, the double earth year suggests that we are in for
a calmer year. However, without any element of fire, it is unlikely that a
strong economic recovery or sharp stock rally will ensue. In sum, an Ox year does not mean a bullish year;
rather, it means a calm year. On commodities, the year is good for grains and
fertilizers (earth), but only neutral for the energy and metals sectors (lack
of fire and metal).
■ A final note:
please regard the above discussion as light-hearted entertainment; we will get more
serious in the next section.
Macro – After the Spring Festival, Play a Spring
A Summary of the Macroeconomic Data for December
■ China’s GDP
grew 6.8% year-over-year (YOY) in Q4/08, the slowest pace in seven years.
production (IP) grew 5.7% YOY in December, rebounding from the 5.4% growth seen
in November and higher than economists’ consensus of 4.2%. Both crude steel output and electricity output
climbed on a month-over-month (MOM) basis, up 7.3% and 7.8%, respectively.
■ Retail sales
increased 19% YOY last month, down from the 20.8% growth in November. Urban
fixed asset investments climbed 26.1% YOY year-to-December, compared with the 26.8%
growth seen year-to-November. We observe that both retail sales and fixed asset
investment data were reported on a nominal basis. If adjusted for the sharp
decline in inflation, the real growth in both domestic consumption and
investment has been holding up very well.
■ CPI growth
slipped to only 1.2% YOY in December, and the PPI declined by 1.1% YOY, the
first negative growth since December 2002.
Five Observations on Macroeconomic Trends
■ First, the
sequential pick-up on IP and PMI numbers in December shows that the economy is recovering
from the sudden engine failure in October. As Chinese Premier Wen Jiabao put
it: “In December, industrial sales were picking up; inventories were lower in
certain sectors; and electricity output was recovering. Macroeconomic data in December are better than
expected and show early recovery signs.”
■ Second, we
expect Q1/09 data to remain subdued, if only because of statistical base
effects. China reports macroeconomic data on a YOY basis, and back in Q1/08,
the Chinese economy was still growing strongly at a 10.6% pace and therefore
represents a high base to compare with.
■ Third, we think
Q4/08 and Q1/09 will represent the trough of the ongoing economic down-cycle. After this trough, top-line growth numbers are likely to recover
gradually, beginning in Q2/09.
■ Fourth, we
expect China’s real economic activities to meaningfully rebound into the spring
(Q2/09). As we wrote in our China
Commodities Weekly published last
week: “the ongoing winter lull will be followed by a spring revival. When the
money is ready (loan additions are already 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 of manufacturing/construction activities in
March and April looks highly likely.”
■ And lastly,
after the spring revival, we expect China’s real economic activities will slow down
again, as the economic down-cycle still prevails. However, macroeconomic data
are likely to surprise on the high side, driven by the low statistical base
effect. Again, China reports most macro data on a YOY basis, and Q3/08 and
Q4/08 will offer low statistical bases to compare with for Q3/09 and Q4/09.
■ As we have written repeatedly in our recent
reports, we believe investors
should buy any
major dip before the end of
February, preparing the portfolio for a tradable rally in the
raw materials sectors driven by the potential
spring revival in China. (After that, “sell in
May, and go away” might still be advisable.)
■ In terms of individual commodities, we suggest investors pay more attention to those
commodities that China can
“save,” as our central case is that while China might enjoy
a spring revival, the rest
of the world would still be facing a deepening recession.
A Lesson from Copper
■ The recent market behaviour of copper offers a good
lesson for those bulls whose call is solely based on China. China’s refined
copper imports have been on the rise in the second half of 2008; and in
December, it grew a massive 49% MOM and 89% YOY to a record high of 211,527
tonnes. It was very clear that China’s copper imports were very strong, but the
problem is, as one of our supply-side contacts (who sells 5% of world copper)
puts it, “no one is buying besides the Chinese.” In this environment, the strength
in China did not prevent the LME copper price from crashing.
■ Therefore, it is worthwhile to recall China’s share
in world consumption of major commodities. Investors should pay more attention
to those commodities for which China is the key driver.
■ To that end, we note that in 2008, China consumed 9.2% of the world’s oil, 23% of
nickel, 27% of copper, 32% of fertilizer (35% N, 32% P, 24% K), 33% of zinc,
36% of aluminum, 37% of crude steel, 39% of coal, and 51% of seaborne iron ore.
■ In the past, we formed our views on an individual
commodity purely based on whether China would be a supportive or negative
factor for the commodity under discussion. Taking copper again as an example,
we have been positive on copper from a China perspective; and our stance has
been proven right – China’s copper imports surged to record levels. But this did
not prevent the LME copper price from dropping below US$1.50/lb.
■ As a partial remedy for this situation, in the
future, we will continue to form a view on a given commodity based on whether
China is a supportive factor or not, but we will also add a secondary
consideration – whether China is a dominant driver or not. With this, we have decided
to change our calls on the two ends of China’s market share spectrum.
Specifically, we have downgraded our view on crude oil to “neutral” from “positive”
and have upgraded our view on iron ore to “positive” from “neutral.”
■ The IEA believes that in 2009, growth in China’s
demand for oil would only be 90,000 bpd. In contrast, we believe that China’s
demand for oil would grow at least 250,000 bpd this year. Therefore, compared
to market consensus, our view is more positive on oil from a China perspective.
That said, as China consumes only 9.2% of the world’s oil, the gap between
250,000 bpd and 90,000 bpd does not make much difference, particularly for a market
that sits on increasing OPEC spare capacity and high global inventory. If the
OPEC spare capacity is thin, as in the early part of 2008, incremental barrels
at the margin make a big difference. In fact, in the first half of 2008, China’s
pre-Olympic stocking of oil and oil products squeezed the already-thin OPEC
spare capacity, and thereby helped push the crude oil price to triple-digit
levels. But the situation has changed now. With increasing OPEC spare capacity,
China’s influence as the source of incremental demand has decreased.
■ Long term, however, we remain an oil bull. As U.S.
Fed’s Richard Fisher put it: “If China used the same amount per capita as
parsimonious Japan, Chinese consumption would total more than 18 billion
barrels a year, an amount that dwarfs our country’s 7.5 billion barrels.”As a
secular bull on China’s urbanization story, it is very hard for us not to
subscribe to the case for a long-term bullish view of crude oil.
Iron Ore – The First Candidate to Benefit from a
■ In contrast to oil, China consumes 51% of world’s seaborne
iron ore. For iron ore, the Chinese domestic market situation largely
determines global iron ore pricing. In fact, the global spot market price for
iron ore is set in China. Therefore, iron ore would be the first candidate to
benefit from a spring revival in China, even if the rest of the world were
still in deep recession.
■ Interestingly, we note that the latest data show
that in December, domestic iron ore output was down 15.6% MOM and 8% YOY to
61.06 million tonnes; and in the same month, China’s imports grew 6.2% MOM and
1% YOY to 34.527 million tonnes. As we have repeatedly pointed out, China’s
domestic iron ore production sits on the highest end of the global cost curve.
As a result, sharply lower prices have curbed domestic output. At the same
time, iron ore inventory has been drawn down in the past two months (see Chart
of the Week), and imports have begun to rebound. (See output and trade charts
on the iron ore page.)
■ As for the 2009 contract, we still look for a 30%
drop in the benchmark contract price. We believe the equity market has priced
in a drop of this scale, if not larger.
News in Brief
Grain – China Added Reserves
■ China added 6.1 million tonnes of grain to the
state reserve and 4.3 million tonnes of grain to local government reserves in
2008, according to the China National Grain and Oils Information Center.
Fertilizer – Urea Exports Small, So as Potash
■ In December 2008, China exported 36,615 tonnes of
urea, up 5.5% MOM but down 97.6% YOY. This shows that even with only a 10%
export tax, Chinese urea was not competitive.
■ In December 2008, China exported 75,427 tonnes of
DAP, up 171.4% MOM but down 55.8% YOY. This number is in line with our expectation.
■ In December 2008, China imported 318,948 tonnes of
potash (MOP), down 43.5% MOM and 57.5% YOY. This number is bullish in nature
for the potash sector. Going into 2009, China’s 2008 import contract has
already expired and imports into China in Q1/09 will likely be even lower.
Wheat – Facing Drought
■ China’s Ministry of Agriculture reports that a lack
of rainfall has “impacted” about 7.9 million hectares of winter wheat and “caused
drought damage” on 1.7 million hectares. Last year, China’s total planting area
was 23.9 hectares with a yield of 4.7 tonnes/hectare. Assuming the damage
caused a 30% loss in yield, the crop loss would be 2.4 million tonnes. In
contrast, in 2008, China’s wheat harvest increased 4 million tonnes as compared
■ For winter wheat crops, a drought at this time of
winter can be easily reversed by rainfall in the spring. The damage, if any,
would be more related to winter kill for lack of snow coverage. If the winter
kill is too heavy, a spring wheat/corn crop can be planted as a remedy.
■ That all said, if the drought lasts into the
spring, the situation will materially worsen.
Coal – Some Thermal Power Plants Low on Coal
■ Over the first 11 days of January, coal stockpiles
at China’s key power plants fell by 17.27% to 37.76 million tons. The drop was
especially noticeable in the northern and northeastern regions, where
stockpiles dropped by 21.02% and 27.72%, respectively.
■ Some thermal power plants in China saw
lower-than-average coal stockpiles last week, as their annual coal contracts
have expired and they have not yet signed new ones for 2009. Coal miners are
reducing delivery and demanding a higher contract price than power plants are
willing to pay.
Economy – Health Care Reforms Approved
■ The State Council said last week that it would
spend about RMB850 billion (US$124 billion) on health care reforms over the
next three years to offer more comprehensive coverage in both urban and rural
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 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
■ Individual Commodity Sectors: On
individual commodity sectors, we are now positive on the copper, steel, iron
ore, uranium, potash, DAP, and hardwood pulp sectors. We are neutral on
aluminum, zinc, nickel, molybdenum, coking coal, thermal coal, urea, wheat,
corn, soybean, methanol, ethylene, and crude oil. We are cautious on paper
■ Please note that our positive, neutral, or cautious
views on individual commodity sectors are all on a relative basis from a China
■ 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.