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Msg  59329 of 65647  at  2/12/2009 4:38:02 PM  by


China Update

China Update

China Commodities Weekly for the Week of February 9-13, 2009

So far this week, China’s base metals markets were flat, but steel prices corrected. Chemicals, fertilizers, and grain prices were slightly firmer. Coal prices were flat, while oil products prices dropped.

In this note, on the macro side we discuss trade, property, electricity, and auto data for January. We also discuss the underlying forces (re-stocking or real demand pickup) for the recent commodity and freight market strength. On the commodities side, we examine the purchase intention of 20 million tonnes of coking coal announced by Shandong Province. We also explain why we have upgraded our view on urea and downgraded our view on potash from a China perspective.

Macro – Re-stocking or Real Demand Pickup?

In the past two weeks, our investment theme “After the Spring Festival, Play a Spring Revival” played out to certain degree, particularly in the iron ore sector, which we upgraded in January. To reflect the strength, the Baltic Dry Index has been moving materially higher, and according to one of our freight market contacts, “very few cape-size vessels are idle now; many of them, over 130, are heading to China or waiting at Chinese ports with iron ore.”

The situation invites a question: is this increased activity due to re-stocking or a pickup in real demand in China? Our answer, based on anecdotal conversations with local contacts, is that for the time being, it is driven more by re-stocking than by real demand.

That said, re-stocking happens for a reason: producers, traders, and wholesalers do expect demand to pick up meaningfully in the spring. As always, the market moves on higher expectations and increased confidence. Why are traders more confident today? Simple: the huge loan growth seen in December and January. Today’s loan growth translates into activities in the spring. Local traders saw this every year in the past six years, and when they heard the loan growth numbers this winter, they re-stocked iron ore, steel, and metals in anticipation of the pickup in construction activities in the spring funded by the loans already made.

But nothing goes in a straight line. Some consolidation will occur before the market fully establishes a new trend. The resumption of demand will come, but may come with a choppy start. In fact, over the past three days, steel prices in China began to give back some gains in certain regions. A “V” shape jumpstart in demand is not likely, given the global economic environment, and a “W” shape is probably more realistic. Therefore, we would continue to suggest investors “buy the dips” rather than chase the momentum (easy to say, we know).

As a matter of fact, although the markets have moved up on expectations, the concurrent indicators still depict an economy in a downturn. Higher expectations for the spring are constantly dampened by the dismal concurrent economic data, such as sharply lower exports and imports in January. In addition, China’s auto, property, and electricity markets still posted year over year (YOY) sales losses last month, although the YOY losses were exaggerated by the Spring Festival, which fell in January this year and February last year.

Trade – Sharply Lower Imports and Exports

China’s exports fell 17.5% YOY in January 2009, after a 2.8% YOY drop in December 2008. Imports plunged a massive 43.1% YOY, twice as much as December’s 21.3% YOY decline. Both imports and exports dropped the most since 1993, when the monthly data series began.

Interestingly, the trade data might not hurt China’s GDP number as much as anticipated by economists. China’s monthly trade surplus reached US$39.1 billion in January, just shy of November’s record of US$40.1 billion. The pattern in the past few months continued – exports dropped, but imports dropped even more drastically. That being said, a sharp decline in imports does not depict a rosy picture of domestic consumption, just as a sharp drop in exports does not depict a rosy picture of overseas consumption.

As for individual commodities, China’s crude steel imports in January fell 8% YOY and 11% month over month (MOM) to 3.02 million bpd, the lowest in 15 months. Net imports of refined oil products also dropped 22.2% MOM and 37.6% YOY. Imports of unwrought copper and copper semis fell 19% MOM from December’s record level to 232,701 tonnes in January. Iron ore imports fell 5% MOM and 11% YOY in January to 32.65 million tonnes.

On the export side, China’s exports of finished steel products fell 40% MOM and 54% YOY to only 1.91 million tonnes last month, the lowest in nearly three years. Coal exports were also down 36.3% YOY and 18% MOM to 3.66 million tonnes in January.

Once again, we caution about reading too much into the trade data in January, as the Spring Festival fell in the month, cutting at least five working days and distorting MOM and YOY comparisons.

Auto – January Car Sales Lower

China’s car sales dropped 7.76% YOY, but climbed 4.44% MOM in January to 610,600 units. Total vehicle sales dropped 14.35% YOY and 0.83% MOM to 735,500 units in the same month.

Interestingly, China’s total vehicle sales overtook the United States in January, although this is likely to be a very temporary phenomenon. In January, 656,976 units of vehicles were sold in the United States, according to Autodata.

Property – Sales Drop in January

Mainland property sales have experienced a MOM slowdown in major cities in January, especially during the Chinese New Year holiday, after a policy-driven rebound at the end of 2008. This confirms our view that the Chinese property market has not bottomed out yet, both in terms of sales and price.

MOM transaction volumes were down 41% in Shenzhen, 28% in Guangzhou, 37% in Shanghai, 55% in Beijing, 23% in Chongqing, and 12% in Chengdu. On YOY basis, all the above cities posted a decline, except for Shenzhen.

Electricity – Power Output Dropped in January Again

China’s power output from plants connected to major grids dropped 13% YOY and 9% MOM in January to 250.3 billion kWh, a fourth straight decline that was likely exaggerated by the week-long Chinese New Year holiday.

Power output from thermal plants connected to major grids was 212.5 billion kWh in January, down 17.4% from a year earlier.

By January 31, the power plants connected to major grids had 36.4 million tonnes of coal in stocks, down 7% from three weeks earlier, but the stocks were still sufficient to last 20 days.

Coking Coal – An Intention of 20 Million Tonnes

The Shandong Coking Industry Association has signed an Agreement of Intention to purchase 20 million tonnes of coking coal from Swiss firms Glencore and International Metallurgical Resources (IMR). According to the association’s website, the Agreement of Intent was signed on January 23, 2009. The association said it represented 55 large coking firms in the province in the deal, which would be worth US$3 billion.

We observe that the coastal province of Shandong has a combined annual coking capacity of 45 million tonnes, and needs 60 million tonnes of coking coal a year. The association said that it signed the agreement to prepare the coking firms with sufficient raw materials for the upcoming economic recovery. Last year, when the coking coal market was hot, domestic coke producers suffered a significant margin squeeze due to the high-flying domestic coking coal price. Therefore, the Agreement of Intent might just serve as a warning to domestic coking coal suppliers of the alternatives available.

Indeed, an official at the Shandong Coking Industry Association, who declined to be named, said that “It is only an intention, not a firm supply contract.” However, he also said that the 20 million tonnes would be delivered over a year, if domestic coking coal prices surged again.

We believe that it is extremely unlikely that China will import 20 million tonnes of coking coal in a year, given the scale of the quantity. Official customs data shows that, in 2008, China imported 6.86 million tonnes of coking coal and exported 3.4 million tonnes.

That said, for the time being, domestic coking coal is trading at a slight premium to the international spot market price, particularly in China’s coastal regions like Shandong Province. It does make some economic sense for coastal regions to import some coking coal, rather than to take delivery from China’s interior coal-producing provinces. We are hearing that, just recently, a couple of shipments were traded to China at around US$150/tonne.

We further note that the Agreement of Intent implies an import price of US$150/tonne (US$3 billion for 20 million tonnes). We maintain our call for a US$130/tonne coking coal benchmark price (FOB Australia) for the 2009 coal year.

Potash – Downgrade to Neutral

Last November, we upgraded our view on the potash sector to bullish from a China perspective, due to low expectations and “supply disciplines.” In the past two months, the market began to buy into the idea that supply discipline will lead to a better-than-expected China contract price, and the sector has outperformed.

But supply discipline has a cost: that is, lost sales volume. We have been looking for a US$24/tonne hike in the potash contract price in 2009. If we are right, China might take some 6 million tonnes of potash from overseas this year. Our Chemicals and Fertilizers analyst, Sam Kanes, looks for a much higher contract price hike. If Sam is right, China might take only 3 million tonnes of imports.

Last year’s potash contract was US$576/tonne FOB, or RMB3,930/tonne. Taking freight, discharging cost, and carry charges into consideration, a port sales price at over RMB4,500/tonne is basically the break-even point for last year’s imports. For the time being, although the nominal port quotation by Sinochem is still at RMB4,600/tonne, the average retail prices have slipped to the RMB4,200/tonne range. This had made last year’s imported material unprofitable. In this environment, it is doubtful that Sinochem and Sino-Agri will accept any price over US$600/tonne for the 2009 contract. If they do, they will take the risk that farmers may refuse to pay for the high-priced materials.

As a result, we have downgraded our view on the potash sector to neutral from bullish, but we maintain our call of a US$24/tonne hike for the 2009 China potash contract.

On the urea and DAP side, we are now officially in the planting season. The export tax has been hiked to 110% for both fertilizers since February 1, 2009. With a 110% export tax, China’s exports of urea and DAP will disappear in the next few months (except for some 120,000 tonnes of urea that has already cleared customs to bonded warehouses). As such, China will become a positive factor in the global urea and DAP markets, and we have now upgraded our view on urea to positive from neutral purely from a China perspective and we maintain our positive view on DAP.

News in Brief

Coal – NDRC Intervenes in the Stalled Price Talks

China’s top economic planning agency has proposed a 5%-8% price increase for annual coal supply contracts this year, the official China Securities Journal said this Tuesday. The National Development and Reform Commission (NDRC) has submitted the proposal to the State Council, as price talks between coal suppliers and power generators have stalled since December, the paper quoted an unnamed source as saying.

Macro – PBOC Not Worried by Lending Spike Yet

As we reported in the past three weeks, China’s new yuan lending is expected to surge to RMB1.2 trillion-RMB1.6 trillion, When asked by media whether the rumoured RMB1.6 trillion loan growth in January is seen as excessive, PBOC Chief Zhou Xiaochuan said lending has been pushed up by China’s monetary stance, and further observation is needed to make the final sum as banks take up the government’s calls to extend loans to prop economic growth. The loan data is only the end result, which should be monitored closely, but further analysis would be needed to determine whether it is excessive.

Economy – Inflation Gone

China’s CPI grew 1% YOY in January, a two and a half year low. PPI dropped 3.3% YOY in the same month, representing its second consecutive decline.

Oil – Crude Runs Up in February

Twelve major refineries, accounting for a third of China’s total refining capacity, plan to boost runs 5% to 2.37 million bpd in February, according to a Reuters survey, after cutting them to a nearly two and a half year low by the end of 2008.

Electricity – Installed Capacity Might Top 860 GW by Year-End

China’s total installed capacity might increase to a record 860 GW by the end of 2009, up 9% from the end of 2008, according to a forecast by the China Electricity Council. Installed capacity gained 10.3% last year to 790 GW by the end of 2008 after rising 14.6% in 2007.

Re-cap 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 re-cap 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, and hardwood pulp sectors. We are neutral on aluminum, zinc, nickel, molybdenum, coking coal, thermal coal, potash, 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 potash 2009 China contract to increase by US$24/tonne to US$600/tonne.

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