China Commodities Weekly for the Week of
April 13 - April 17, 2009
Investments Grew strongly
Q1 GDP Likely
to Be Lowest in 2009
■ China’s GDP expanded 6.1% year-over-year (YOY) in
the first quarter of 2009, the lowest quarterly GDP growth in almost twenty
years, after a 6.8% gain in Q4/08. We observe that the Q1/09 GDP is highly
likely to be the lowest quarterly GDP figure in 2009, for two reasons:
fundamentally, going into the rest of this year, the huge loans addition in the
winter months and the stimulus package implemented by the government will
gradually show their full impact in the real economy; and statistically, China
reports its GDP data on a YOY basis – the Chinese economy was strong in Q1/08,
but had slowed down markedly since then throughout the rest of 2008, offering a
statistical base that is easier to compare with for the rest of 2009.
■ Although we believe the Q1 GDP figure is likely to
be the lowest in 2009, whether it is the trough for this economic down cycle is
still unclear, much depending on whether the Chinese economy follows a “V”
shape or “W”shape recovery. We note that, historically, Chinese economic
growth, once peaked, usually suffers from a multi-year slowdown. For the time
being, we continue to call ourselves “a cyclical bear” (while remaining a “seasonal
bull” and a “secular bull”).
Asset Investment Growth
■ As for other key data, as Chinese Premier Wen
Jiabao already leaked last weekend, industrial production (IP) expanded 8.3%
YOY in March, compared with 3.8% in the first two months. We note that this
pickup in IP growth came despite a steep fall in exports, which were down 17.1%
YOY in March.
■ With the IP data already known to the market, the
urban fixed-asset investment (FAI) data is the only bright spot in last week’s
National Bureau of Statistics (NBS) report. In March, China’s urban FAI climbed
30.3% YOY, up from 26.5% in the first two months. Noticeably, China’s fixed asset
investment continued to move into the interior regions of the country. In
Q1/09, FAI in the costal region (eastern region) was up 19.8%, in mid-China
region it was up 34.3%, and in western China it was up a massive 46.1%.
■ All other data for March are essentially in line
with market consensus, with retail sales up 14.7% YOY in the month, CPI down
1.2% YOY, and PPI down 6% YOY.
■ With the strong IP and FAI data, we maintain our “overweight”
call for the global raw materials sectors from a China perspective.
Output Still Sluggish
■ As we have pointed out repeatedly, electricity
output is a key concurrent indicator of the strength of near-term industrial
activities in China. In the second half of March, China’s power output was not
as strong as it was in the first half, resulting in a 1.3% YOY drop of power
output in March overall.
■ This sluggish electricity production continued in
April. Nationwide, electricity supplied via major grids fell 3.57% YOY during
the first ten days this month, compared with decline of 1.3%, 2.2%, and 2.7% in
the first, second, and third ten-day periods of March, according to the
National Electricity Dispatching and Communication Centre, a unit of the State
■ Although we do not read too much into one data
point, as electricity output is also heavily influenced by weather conditions,
we do note that the sluggish output does not confirm the reported strength in
IP and FAI growth. Similarly, the steel price in China, another key indicator,
remains under pressure and does not point to strong construction activities
overall. These are the two disconcerting signals from the real economy which
run against the strong macroeconomic data and which commodity bulls (us
included) should be aware of. On the positive side, however, we note that China
reported some small drawdown of steel inventories in the past two weeks and the
freight market begins to recover slightly.
■ Over the past weekend, Premier Wen Jiabao shared
his assessment of the Chinese economy and indicated his policy bias. “A series
of economic stimulus measures adopted by China have shown initial results and
there have been positive changes in economic performance, which has been better
than expected,” he said.
■ But Wen also cautioned that China would still err
on the side of the caution, sticking to its active fiscal policy and moderately
loose monetary policy. “We would rather overestimate the severity of the
situation and fully consider difficulties in making longer-term preparation for
bigger difficulties,” he said.
■ Similarly, central bank governor Zhou Xiaochuan
also emphasized that, even though there were positive signs that the economy is
starting to recover, China is still at the stage of struggling against the
global economic slowdown and financial crisis.
Time to Tighten
Up a Bit?
■ Even though the policy bias from the top leadership
remains expansionary, it seems that Chinese banks are beginning to tighten loan
rules and increase scrutiny on the use of borrowing, as explosive growth in
lending fuels risk concerns. For example, the Bank of China has issued
guidelines to its branches to monitor borrowers and the flow of loan capital. Construction
Bank has started to inspect consumer loans to ensure they are used for their intended
purposes and not for speculation on the stock market.
■ Liu Mingkang, chairman of the China Banking
Regulatory Commission (CBRC), warned banks to step up their vigilance in
managing the credit explosion last week. “We should pay close attention to risk
accumulation as bank lending surges,” he said. The CBRC will soon issue
stricter lending guidelines to banks to ensure proper use of loans, according
to the official China Securities Journal.
■ In the past few weeks, Chinese fertilizer markets
have been falling across the board. The seasonal factor is partially
accountable for this, in our opinion. For the time being, the fertilizer
application for the spring planting season in Northern China is almost
completed, but the major application season in Southern China has yet to start.
Urea – Domestic
Prices to Drop More to Match Export Orders
■ On the urea market, mainstream ex-factory prices
have dropped to RMB1,750-1,850/tonne. In certain regions, prices have dropped
to RMB1,700/tonne or even lower. We note that starting July 1, China will
reduce its export tax for urea to 10% from 110% 10%. Assuming RMB1,700/tonnes,
ex-factory, we calculate that Chinese urea export quotation should be around
US$290/tonne including tax. We note that recent offers from China to Bangladesh
reflected export prices no higher than US$265/tonne. This indicates that Chinese
traders and exporters expect urea prices to continue to drop in the coming
months into the off season.
■ In China, producing one tonne of urea requires
0.7-1 tonne of coal (most likely to be anthracitic coal) as input. The
production process further consumes some 0.5-0.9 tonnes of thermal coal as
fuel. For the time being, delivered price (to urea plant) for anthracite coal
is about RMB800-850/tonne, and delivered price for thermal coal is about
RMB480/tonne. Based on this, we calculate the coal cost for urea producers in
China is about RMB900-1,250/tonne. Including other costs, we believe China’s
average urea production cost is at around RMB1,500/tonne. This is why, if coal
prices remain stable in China, due to excessive competition we expect the
Chinese urea price to eventually drop below RMB1,500/tonne exfactory at
off-season, indicating an export value of lower than US$255/tonne. At this
level, Chinese exporters would be able to make some exports during the
off-season, if the international market maintained its current level in the
DAP – Domestic
Prices to Drop More to Match Export Orders
■ In recent weeks, ex-factory prices for DAP (64%)
have dropped to RMB2,600-2,700/tonne in China. As the high-priced sulphur
inventory depleted and sharply lower sulphur price (now close to US$50/tonne
CFR China) begin to reflect in production costs, we expect China’s DAP
production cost to drop to around RMB2,000/tonne into the off-season. Officially,
China’s export tax will be cut to 10% beginning on June 1, 2009 (one month earlier
than urea). At 10% export tax and RMB2,000/tonne ex-factory price, we calculate
China’s DAP could be offered at US$335/tonne.
■ We note a market report that China’s YTH and Wengfu
are negotiating a large supply deal with India’s IPL and IFFCO, with a proposed
tonnage of 400,000-600,000 tonnes. Prices were offered by the Chinese side at
US$370-375/tonne but were rejected by the Indian side. The Indian side, in
turn, is now hoping to pay around US$350/tonne, but this is reportedly being
rejected by both Chinese suppliers.
SinoChem and Sino-Agri Tried to Support Market
■ Last week, China’s two potash importers, Sinochem
and Sino-Agri, tried to halt the quick slide of domestic potash prices. After a
special meeting on April 15, the importers declared that their port quotation
for Russian red, Russian white, and Canadian red would be RMB3,700, RMB3,800,
and RMB4,100/tonne, respectively, for only one week. The importers urged end
users to place their orders during the week, as prices for all the grades will
be hiked by RMB200/tonne one week later.
■ We note that this move shows that the importers are
panicking. Chinese importers now hoard over 3 million tonnes of potash
inventory left on hand after China’s major NPK production season. The import
cost for the majority of this inventory was well over RMB4,250/tonne. Last
week, China’s average retail potash price dropped to RMB3,916/tonne. In other
words, Chinese importers are stuck with a loss from their import program last
year, as Chinese NPK producers and farmers refuse to pay sky-high potash prices.
For the time being, the importers are trying to clear their inventory at ports
(through the move mentioned above), and should have no incentive to book large
volumes of potash in the near term if overseas suppliers insist on a higher
price. We maintain our call for a flat import price in 2009 versus 2008.
Molybdenum – A Storage of Value?
■ Last week, led by the 304 series, China’s stainless
steel market spiked higher, helped by the sharply higher nickel prices (see
Chart of the Week).
■ It is debatable whether the nickel price rally is
sustainable. Some local observers believe that it is investors, not real end
users, who have been buying nickel lately. As Antaike puts it, “Compared with
copper and aluminum, nickel is more valuable. When you want to use 1 million
yuan to buy physical metal, you could get about 10 tonnes of nickel only, it is
a small amount and easy to store.”
■ As the argument goes, nickel is twice as valuable
by weight as copper, and eight times more valuable than aluminum, making it a
metal that can be stored by private investors who normally do not have large
storage space. Unlike gold, it’s an industrial metal that offers leverage to
the Chinese economic recovery.
■ “We sold an average of 100 tonnes of refined nickel
a day in the past two weeks, compared to the normal 30 to 40 tonnes level,” a nickel
sales manager at a trading house in Shanghai said. “About 90% of the sales were
to people whose businesses are not nickel.” It is rumored that investors such
as rich businessmen in coastal Zhejiang and Jiangsu provinces were interested
in stocking up on nickel as part of their investment portfolio.
■ Some local investors were also expecting the
government’s State Reserves Bureau to buy nickel after it bought copper, aluminum,
and zinc in the past few months. In early March, industry sources said the SRB
could buy 10,000 to 20,000 tonnes of refined nickel, but there has been little
evidence of action so far.
■ In our opinion, although investment demand plays a
role in the recent nickel price rally in China, there are also some fundamental
reasons for it that should not be ignored. First of all, although it was
initially the nickel price rally that triggered the stainless steel price
spike, the sharply higher stainless steel price could in turn trigger
re-stocking demands for it, and thereby push nickel demands higher. Secondly,
like copper, we understand that there is a severe shortage of stainless steel
scrap. As the secondary supply dries up due to low prices, demand for primary
nickel has to make up the void. Thirdly, sharply lower nickel prices have
virtually killed nickel pig iron production in China, which was a very
important (albeit high cost) supply of nickel content when primary nickel was
in shortage two years ago. And lastly, maintenance work at Jinchuan Group,
China’s largest nickel producer, might also have contributed to the recent
local shortage. The latest NBS data shows that China’s nickel output dropped
5.9% month over month (MOM) in March to 16,063 tonnes.
■ In the very near term, the Chinese market is likely
to remain tight, and the Shanghai-LME price ratio continues to support imports.
China’s imports of refined nickel and nickel alloy surged 66% MOM to 12,690
tonnes in February. Data for March is expected to be released next week. We
expect the imports to top 20,000 tonnes in March. Given the prevailing
Shanghai-LME price ratio, we expect China’s nickel imports to remain high in
April and May.
■ On the negative side, however, it is apparent that
the LME inventory remained at a very high level and the global nickel industry
is running at a low capacity utilization ratio (around 70%). As we have written
repeatedly, for any given commodity, its inventory and its spare capacity are
the two components of its supply cushion. If the supply cushion is too high,
the commodity price is likely to be capped on the upside. Unfortunately for the
bulls, nickel fits this description very well; and this differentiates nickel
from copper, for which the supply cushion is much lower, with one week of
demand LME inventory, very low SHFE inventory, and a 90% industry run rate. And
this difference explains why we maintain our bullish view on copper and our
neutral view on nickel.
■ Finally, a word on molybdenum. If nickel is viewed
as a way to store value, why not molybdenum, which has a higher value? In the
form of ferromoly, the metal is very stable and easy to store (although in
oxide form one has to make sure the material is kept dry). The only fatal
disadvantage for molybdenum as a storage of value is that it is not traded on
the LME, and it is
perceived to be illiquid and less tradable. But if and when the demand for stainless
steel picks up both metals will benefit.
March Output Data Review
■ Last week, the NBS released the production data for
key commodities. China’s copper output grew 5.2% YOY but dropped 0.2% MOM in
March, to 319,400 tonnes. The sluggish domestic output data supports our
bullish view on copper.
■ As for aluminum, domestic output dropped 16.4% YOY
but grew 0.9% MOM in March to 902,300 tonnes. Domestic production is likely to
gradually recover, however. We estimate Chinese producers are restarting at
least 750,000 tonnes of spare capacity to take advantage of the recent price
■ The NBS also reports that China’s zinc output grew
8.2% YOY and 30.1% MOM in March to 344,200 tonnes.
■ China’s iron ore output remained abated on a YOY
basis, down 1.1% to 61.722 million tonnes. As we wrote last week, sharply lower
iron ore prices have pushed some small, high cost iron ore producers to shut
down production. On the crude steel side, however, the NBS reported a monthly
output of 45.101 million tonnes, or 531 million tonnes on an annualized basis,
much higher than the 505 million tonnes reported by the China Iron and Steel Association.
Over the past weekend, BaoSteel’s chairman said that China’s steel prices will fluctuate
at a low level this year because of the industry’s overcapacity.
■ As for coal, China produced 233.427 million tonnes
of coal in March, up 10.3% YOY and 18.8% MOM. We note that the strong coal
output growth was mainly driven by large state owned producers. For example,
Shenhua Energy, China’s largest coal producer, saw its commercial coal output
shoot up 26% YOY and 28% MOM in March.
■ On the oil side, China’s crude run was up 0.7% YOY
and 13.9% MOM to 29.375 million tonnes. At 6.92 million barrels per day, the
March run rate is the highest since October 2008 and represents the first YOY
rise in five months. The stronger run rate explains the strong crude oil
imports last month, which rose to the second highest on record. Separately,
local media reports indicate that China’s oil products inventory might finally
have begun to decline. Fuel inventories held by China’s top refiners fell 14.7%
in March, the first sharp decline in over two years, according to the China
Petroleum and Chemical Industry Association (CPCIA). Sales rose by 21% versus
February, an increase likely due in part to the longer month of March.
Recap of Our
■ 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 weight, 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, uranium, molybdenum, urea, DAP,
methanol, and hardwood pulp sectors. We are neutral on aluminum, zinc, nickel,
coking coal, thermal coal, potash, wheat, corn, soybean, 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 35% drop in the 2009 annual iron
ore contract. We expect the 2009 China potash contract price to be flat versus
2008 contract at US$576/tonne.