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Msg  59275 of 65647  at  2/5/2009 9:36:24 PM  by

KevinKT


China Update

I was surprised that there is a China Update from Na Liu of Scotia today, as we are still in the second week of Chinese New Year.

China Commodities Weekly for the Week of February 1-4, 2009

In this report, we discuss the behaviour of China’s domestic commodity markets after the Spring Festival. We further elaborate on our “After the Spring Festival, Play a Spring Revival” theme by discussing China’s loan growth and overnight PMI data. We also look into China’s methanol markets, which feature huge import and large output cuts.

In this report, we discuss the behaviour of China’s domestic commodity markets after the Spring Festival. We further elaborate on our “After the Spring Festival, Play a Spring Revival” theme by discussing China’s loan growth and overnight PMI data. We also look into China’s methanol markets, which feature huge import and large output cuts.

Macro – After the Spring Festival, Play a Spring Revival

Twenty Million Migrating Workers Lost Jobs

About 20 million Chinese rural migrants have lost jobs as the nation’s economic growth faltered. Chen Xiwen, director of the Office of the Central Rural Work Leading Group, told a news conference that a recent survey showed 15.3% of the 130 million migrants moving from villages to cities and factories had returned jobless to the countryside. Adding this year’s six to seven million new entrants into the rural labour market, China will have about 25 million jobless and potentially restive rural unemployed, more than Australia’s total population.

More Spending to Alleviate the Pain

The dire employment picture for the migrating worker demonstrates why the Chinese government will have to heavily and urgently rely on fiscal spending to jump-start the economy.

Last week, the Chinese Premier said in Europe that “During the last 10 days of December, the Chinese economy started to pick up. The goods piled up in ports started to decrease and the price of industrial products started to rise.” To maintain the momentum, Premier Wen said that China is considering fresh, timely, decisive, and pre-emptive stimulus to prevent economic retreat.

He also disclosed that Chinese commercial banks meted out RMB900 billion of new loans in the first 20 days of January 2009. This number comes after a surge in loan additions in December 2008.

In fact, we heard that in January 2009, Chinese banks might have issued a record RMB1.2 trillion of new loans. If proven true, this number is truly massive: it means that in January, Chinese banks may have made 24% of the total amount of loans they handed out in 2008 and 33% of the total amount of loans they handed out in 2007. Exhibit 1 shows the three consecutive months of large loan additions after China scrapped the loan quota control in October 2008. Clearly, in sharp contrast to Western banks, the Chinese commercial banks are still lending and, in fact, they are accelerating lending to support the government’s new policy bias.

With the sharp increase in bank loans, we reiterate our overweight call for global raw materials sectors from a China perspective. “After Spring Festival, Play a Spring Revival” is our current investment theme, as thoroughly discussed in our China Commodities Weekly dated January 23, 2009. This theme is well supported by the latest developments, as commodities prices continue to recover, and order flows continue to improve:

Local Markets Mostly up After the Spring Festival

Over the past few days, the markets in China have reopened with a positive tone after the week-long Spring Festival. The Shanghai Composite Index topped 2,000 for the first time since mid-December 2008. On the commodities side, steel and iron ore markets posted modest gains. The Shanghai copper market registered strong gains two days in a row and continued to trade at premium over the LME. The coal and chemicals markets were largely flat compared with pre-holiday levels. The Baltic Dry Index maintains its recent strength.

Order Flows for Steel Products, Machinery, and Transportation Improving

Overnight data show that China’s Purchasing Managers’ Index (PMI) rose 4.1 points to 45.3 in January 2009, the highest reading since October 2008 when the economy grounded to a halt. The forward-looking PMI New Order Sub-index jumped 7.7 points to 45 in January. We observe that the rebounding of the PMI is very encouraging and indicates that our call for a spring revival of construction activity is increasingly likely.

Looking into details of the data, PMI new orders saw double-digit increases in the area of machinery, transportation, non-ferrous metals, and ferrous metals. In particular, new orders for steel products jumped to 65, the highest among all categories. The second highest new orders are seen for transportation equipment. All these data suggest that government fiscal spending on the infrastructure sectors has started to have an impact on new order flows.

Similar to the New Orders Sub-index, the Import Orders Sub-index jumped 6.6 points to 39.9 in January, also led by orders for machinery and transportation equipment.

Our Views on 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). With the Spring Festival over, on a forward-looking basis we are now turning into a seasonal bull from a seasonal bear in the past few months.

To recap, effective today, we are a seasonal bull, a cyclical bear, and a secular bull.

Methanol – Large Output Cut, Huge Imports

The domestic methanol market in China is truly a showcase of a “free market” dominated by profit-driven entrepreneurs. In late 2008 and early 2009, the market featured large output cuts and huge imports.

On the production side, although China’s domestic coal price dropped significantly from its peak, it has been traded at a premium over the international price. And more importantly, the natural gas price outside China dropped more and even faster. As a result, China’s coalbased methanol producers suffered severe competition (and margin squeeze) from lowpriced imports. They did exactly what they should have done – cut production. In December 2008, China produced only 720,000 tonnes of methanol, down 23.1% year over year (YOY). On an annualized basis, China lost 4 million tonnes of methanol output from September 2008, when China produced a peak of 1.05 million tonnes in the month. We understand that since November 2008, the overall capacity utilization in the country is just slightly over 55%.

As the relatively higher coal prices hurt China’s coal-based producers, overseas natural-gasbased producers, particularly from the Mideast, have been dumping methanol into the Chinese market. In December 2008, China imported a massive and record 361,670 tonnes of methanol, up 350% month over month (MOM) and 1,041% YOY (see Exhibit 2). In 2008 as a whole, China imported 1.43 million tonnes of methanol, up 70% YOY. Among this 1.43 million tonnes, Saudi Arabia exported 429,321 tonnes to China, up 78% YOY, followed by Iran at 278,548 tonnes (up 6.8% YOY) and Oman at 199,305 tonnes (up 183% YOY).

For the time being, the Chinese market is showing what the methanol bulls like to see: local output is being killed by relatively high coal prices, and China is absorbing the low-cost, natural-gasbased methanol produced in the Mideast. That said, the China situation will also likely cap any major rally for methanol prices, as the industry is operating at only 55% of capacity, led by many small profit-seeking entrepreneurs. They can ramp up the capacity utilization rate quickly, as soon as coal-based production becomes profitable again, either due to methanol price rallies or coal cost drops. We maintain our neutral view on the methanol sector from a China perspective.

News in Brief

Copper – Strategic Reserve Bureau (SRB) Buying

China has started buying copper from domestic bonded warehouses and overseas markets, trade sources familiar with the situation told Reuters overnight.

“The buying is being done very quietly and not in one big go. It is from multi-channel suppliers such as domestic bonded warehouses and imports,” the source, who asked not to be identified due to the sensitive topic, told Reuters. “They are doing it drop by drop to avoid sharp price fluctuations,” the source said.

Copper inventories in a major SRB warehouse in Shanghai increased by about 10,000 tonnes last week, when the whole country was celebrating the Lunar New Year and financial markets were closed, two sources said.

The “drop by drop” move was partly due to limited inventories available from Chinese domestic copper smelters, the sources said, in line with a comment by an executive at Jiangxi Copper in January. Back in January, Jiangxi Copper said that domestic inventory is so low that “if we sell to the SRB, we cannot fully fulfill our contractual obligations with clients.”

We also heard rumours that the SRB has bought 300,000 tonnes of copper from a Chilean producer. The delivery schedule is 25,000 tonnes in each of the next 12 months.

As we wrote last year, we expect the SRB eventually to buy 700,000 tonnes of copper in two years. We also expect China’s copper imports to remain at record levels again in January.

Iron Ore – “Surplus Disappears, Prices Up”

Overnight, BHP Chief Executive confirmed our view on iron ore by saying: “the destocking is essentially complete in China, and buyers are coming back.”

Wheat – Still Facing Drought

Official sources indicate that the drought in China’s winter wheat area exacerbated into late January. The drought now has “impacted” about 9.13 million hectares of winter wheat and “caused drought damage” on 2.66 million hectares, both numbers higher than earlier reports. Last year, China’s total wheat planting area was 23.9 million hectares with a yield of 4.7 tonnes/hectare. Assuming the damage caused a 30% loss, the crop loss would be 3.75 million tonnes. In contrast, in 2008, China’s wheat harvest increased four million tonnes compared with 2007.

For winter wheat crop, a drought at this time of winter can be reversed by rainfall in the spring. If the winter kill is too heavy, a spring wheat/corn crop can be planted as a remedy. All that said, if the drought lasts into the spring, the situation could materially worsen.

Oil – Products Inventory Remains High

Top state economic planning body the National Development and Reform Commission said last week that fuel stocks stood at a record high at the end of 2008.

Oil – Building the Second Round of SPR Facilities

China completed the construction of its first four strategic oil bases and put them into use last year, the official China Central Television reported on Tuesday. The country will start building another eight strategic oil stockpiling facilities, including Jinzhou in northeastern Liaoning province, this year.

Coal – Imports to Climb in Near Term

As Chinese domestic coal prices are now traded at a premium over international prices, Chinese traders are arranging more imports into China, particularly from Indonesia and Vietnam. We expect China’s coal imports to rebound both in January and February.

Gold – Output up 4.3% YOY in 2008

China’s gold production hit a record high of 282 tonnes in 2008, up 4.3% YOY, the China Gold Association said this week. China overtook South Africa to become the world’s biggest gold producer in 2007 with an annual output of 270 tonnes.

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 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 overweight, market weight, or underweight 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, 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 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 30% drop in the 2009 annual iron ore contract. We expect the coking coal 2009 contract price to drop to US$130/tonne. We expect the 2009 China potash contract price to increase by US$24/tonne to US$600/tonne.





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59276 Re: China Update - copper RCMac98 11 2/5/2009 10:40:24 PM






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