China Commodities Weekly for
the Week of May 18-22, 2009
Macro – PMI to Dip Below 50?
■ In the past two days, many clients have asked for
our opinion on a widely forwarded competitor’s note, which warned that China’s May
PMI might fall below 50. This should not be anything new for readers of our China Commodities Weekly, as
we have discussed the PMI seasonality repeatedly with the latest discussion
dated May 1, 2009, with the coloured chart shown in Exhibit 1. In the past,
China’s May PMI always fell from April, with an average drop close to four points.
Given April’s reading of 53.5, if history repeats itself, there is a risk of a
sub-50 PMI in May. In our report dated May 1, we called May the transitional
month from the “Spring Revival” (yellow bars in Exhibit 1) to the “Summer Lull”
■ That said, the
purpose of our May 1 report was to explain why we have decided to hold our
ground against this proven seasonality pattern by maintaining our “overweight”
call. In short, what encourages us to fight the tape are (1) the strong loan
growth; (2) the further roll-out of the stimulus package; (3) the strong home
sales and the upcoming restocking by China’s developers; (4) the success in
finding higher-floor prices for key commodities in this downturn; and (5) the
fact that although China has re-stocked, the rest of the world has not.
■ The May PMI is
to be announced at 9:00 p.m. EST on May 31, 2009. If the PMI does dip below 50,
sentiment will be hurt for a while. But 11 days later, people will hear China’s
May IP and FAI numbers, which are likely to be stronger than the potentially
weak PMI implies. This is because China reports IP and FAI data on a
year-over-year (YOY) basis, and May 2008 happened to be the month of the
Sichuan earthquake, which offers an easy statistical comparison base.
Copper – Near-Term Market Dynamics
■ In our China Commodities Weekly published last Thursday, we wrote, “over the past two weeks, the
Shanghai-LME price ratio has been falling. In addition, Chinese buyers for spot
copper imports are paying less in premiums. These are some early warning signs
for slower Chinese copper imports into the summer months.” As these points have
been drawing more attention over the past two days, we elaborate on them as
■ First, we note
that the price ratio between Shanghai and LME has dropped to a level where
full-tax general imports are barely break-even and no longer hugely profitable
(see Exhibit 2).
indicator of local market tightness, the premium of spot Shanghai prices to
front month SHFE futures, also dropped from over RMB2,000/tonne one month ago
to the current RMB330/tonne, indicating the spot market is no longer tight.
■ Physical import
premiums also fell. Singapore and Korea warehouse premiums are quoted at
US$150/tonne above LME cash, down from US$250/tonne in recent weeks. In
Shanghai, copper premiums hover around US$100-US$125 above LME cash for spot
imports, down from over US$200.
■ On LME,
cancelled warrants (metal set to leave warehouses) have been going lower since
May, from as high as 84,000 tonnes down to 50,325 tonnes as at May 19.
■ On SHFE,
exchange-monitored stock rose for a third straight week to 35,389 tonnes last
Friday (see Exhibit 3).
as we wrote in last week’s report, China’s scrap imports are recovering (see
Exhibit 4). Scrap shortage was one of the key drivers for China’s huge refined
copper imports in recent months.
■ So, will copper
prices collapse immediately because of all the above? Not necessarily. As we wrote in our report dated April 27, Exhibit 5 “shows
that in the past two years in a row when China’s copper imports peaked in the
spring, copper prices stopped going higher, but did remain at a high level for
a few months before more serious pullbacks. If history repeats itself, China’s
copper imports are indeed highly likely to peak this spring, but even if this
happens, LME copper is likely to be stuck in a range of US$1.75-US$2.25/lb for
a couple of months, allowing the copper-related equities to catch up.... After
that, the direction of the global and Chinese economy will determine its fate.”
We maintain our positive view on the copper sector from a China perspective,
for the time being.
Oil, Chemicals, and Fertilizer – Adding Mega-Capacity
■ In its “revitalization plan” for the fuel and
chemicals industry, the Chinese government stated on Monday that it will boost
state reserves of refined fuels, its first official plan to expand beyond its
crude reserves, and help cut high inventories held by oil companies.
■ Under the revitalization plan, China will also
expedite building six refining and eight ethylene key projects during 2006-2010
with an aim to start operations by 2011. China will then have three to four
mega-ventures, each with a crude processing capacity of more than 400,000
barrels per day and ethylene capacity of 2 million tonnes per year (tpy).
■ The plan aims to bring the number of China’s
refining bases with a capacity of over 10 million tonnes to 20, and the number
of ethylene bases with a capacity of over 1 million tonnes to 11. It will also
bring the average operating capacity of China’s refining plants to 6 million
tonnes, up from the current 5.7 million tonnes, and the average operating capacity
for ethylene plants to 600,000 tpy.
■ China will at the same time shut down the
undersized, inefficient ones – refineries under 20,000 bpd in size.
■ By maximizing domestic refining facilities, China aims to process 405 million tonnes of crude
oil in 2011, or 8.1 million bpd, some 13% above the current rate.
■ By 2011, China will also be able to produce 15.5
million tonnes of ethylene. In 2008, China produced 9.983 million tonnes of
■ On fertilizers, China aims to boost output to 62.5
million nutrient tonnes, up from 60.13 million tonnes in 2008. The focus will
be on growing potash output. By 2011, China aims to produce 4 million nutrient
tonnes of potash, a target we would see as very aggressive.
■ Aiming to curb worsening pollution caused in part
by the soaring number of vehicles, China plans to move to the third phase of
emission standards nationwide – similar to the Euro III standards in Europe –
starting in 2009 for gasoline and 2010 for diesel, according to the plan.
News in Brief
Nickel – Refined Output to Grow
■ China’s primary nickel output is expected to grow
11% YOY to 230,000 tonnes in 2009, while stainless steel output is to fall 6%
to 6.9 million tonnes, state-owned research group Antaike said on Wednesday.
China’s nickel pig iron output in 2009 is likely to fall to about 600,000
tonnes this year from 700,000 tonnes in 2008, Antaike said.
■ In our view, Antaike’s estimate for stainless steel
output might prove too conservative. We understand that stainless steel
production has been improving in the first five months.
Iron Ore – “Not Giving Ground”
■ China’s steelmakers have not given any ground in
benchmark iron ore price talks, an industry executive said on Wednesday,
denying reports that they could soften their insistence on a 40% price cut.
■ “The position of the Chinese side has never
changed,” Shan Shanghua, secretary general of the China Iron and Steel
Association (CISA), told Reuters in a telephone interview. “Any news about our
changes was speculation.” Shan denied media reports on Wednesday that CISA could
accept a price cut of between 30% and 35%. “It is not sustainable if iron ore
producers keep a high profit margin but steel mills suffer losses. It is common
sense,” he said.
Ministry of Industry and Information Technology issued a notice last week
calling on commercial banks to restrict or cut off credit to steel enterprises
that were “blindly expanding in disregard of the market.” The notice said steel
output was “seriously oversupplied” and imports of iron ore were also showing
excessive levels of growth, creating massive risks for the industry. “Why these
mills can build up stockpiles without concern about cash flow is because they
have bank loans, and we want to cut the chain,” Shan said.
Oil – Jet Fuel Price Hiked
■ China hiked
ex-refinery jet fuel prices by 13% or RMB4,020/tonne. We note that this move will
further fuel the speculation that diesel and gasoline prices will be hiked
Macro – More Control on Loans
■ The China
Banking Regulatory Commission will require banks to temporarily hold in escrow
any loan to fixed asset investment projects greater than RMB5 million or
exceeding 5% of the overall investment, instead of directly giving funds to the
applicants, the official Shanghai Securities News reported. Once the borrower
has worked out contracts or agreements for the funds, the bank will disburse
the money to third parties. The rule is intended to make it more difficult to
misuse bank loans.
officials have welcomed the loan surge so far this year as vital for boosting
the economy, there have also been signs that they are increasingly
uncomfortable with how some of the money has been used. The National Audit
Office said on Monday that some companies had used fake documentation to obtain
low-rate discounted bill financing from banks and re-deposited the money at a
higher interest rate, which had affected support for the real economy and
bloated bank loans and deposits.
■ The National
Audit Office also said local governments had stumped up only 48% of their share
of funding in some cases, as part of Beijing’s RMB4 trillion stimulus package.
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:
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.
commodity sectors: On individual
commodity sectors, we are now positive on the copper, steel, iron ore, uranium,
molybdenum, urea, DAP, and hardwood pulp sectors. We are neutral on aluminum,
zinc, nickel, coking coal, thermal coal, potash, wheat, corn, soybean,
ethylene, methanol, 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
a 35% drop in the 2009 annual iron ore contract. We expect China’s 2009 potash
contract price to drop US$51/tonne from its 2008 level, to US$525/tonne FOB.