China Commodities Weekly for the Week of August 4-August 10, 2009
Base Metals – De-Stocking Looming?
■ It has increasingly become a market consensus that the restocking for Chinese base metals (and steel) markets is now over. The bullish case for base metals, to which we ourselves subscribe to (particularly for copper) is that going forward, fundamental demand, which should pick up into the fall, should support overall Chinese consumption. And in the meantime, the rest of the world has begun to restock. In this scenario, base metals prices might be sustained at current levels without serious pullback, and if supply-side issues emerge, like those already seen in copper, prices can actually climb further higher. This is still our central case; however, we are increasingly concerned about the possibility of a de-stocking in the Chinese base metals markets , and to a lesser extent, in the steel markets.
Some Pullback in Key Sentiment Drivers
■ In our view, base metals, steel, and iron ore inventories in China have risen to such a level that a change in market sentiment could trigger a sudden liquidation of excess stocks, particularly stocks held by speculators. If this happens, the magnitude of a potential price correction for base metals and steel could surprise the bulls. The reason that we bring up this issue at this stage is that the potential catalysts for a market sentiment change are already here: they include the ongoing pullback in the Chinese stock market, the ongoing pullback in the Chinese steel market, the ongoing pullback in the Baltic Dry Index, the worry about potential credit restraint as new loan additions are slowing down, and a potential pullback in China’s property sales after the pent-up demand has been released.
■ Take the Chinese stock market as an example. In our China Commodities Weekly dated July 24, 2009, we wrote: “as the Shanghai stock market almost doubled from last November’s lows, the valuation looks stretched, and a correction might be on the horizon. A correction in the Chinese stock market might hurt sentiment for investors in global raw materials and energy sectors.” That was the first time that we wrote about the Chinese stock market this year. Ten days later, the Shanghai Composite Index reached its peak of 3,477 points. After a further 5.8% drop on Monday, the market closed at 2,870 points, down 17.5% from its peak. The change in sentiment on the Chinese stock market has clearly had an impact on the commodities markets and the raw materials sectors, both lately and yesterday.
■ In fact, we are not suggesting the Chinese stock market performance is anywhere close to being a good reflection of the fundamentals of the Chinese economy. However, the Chinese stock market has become an important driver for investors’ sentiment in the global raw materials sectors. This is because, in the past two years, the Shanghai market first peaked in October 2007, and then bottomed out in November of last year. Since then, the market has led the recovery charge and the majority of the world’s equity markets have followed the Shanghai index higher. Whilst the market cap of the mainland markets is still dwarfed by the more mature Western markets, there is little doubt that the performance of the Chinese index has become one of the forces that drive investors’ sentiment and risk appetite in both emerging markets and commodities markets.
The Inventory Held by “Weak Hands”
■ In the recent run-up of commodities prices, the strong performance of base metals has induced many speculators, many of whom are from other industries, to participate. There are ample reports that some state-owned enterprises, which had easy access to banks loans since early this year, stockpiled copper and other base metals for investment purposes. Their behaviour is not to blame, as their rationale is simple: the base metals not only offer inflation protection like gold, but also offer upside potential if the Chinese economy accelerates. Copper, for instance, is considered both an inflation hedge and the “PhD for macroeconomics.” And even better, base metals are easier and cheaper to store than, say, steel and iron ore. All of these benefits did not escape the eyes of savvy investors in China. Both state-owned enterprises and private entrepreneurs are participating in the “investment” game. Local metal traders have reported many stories of this sort, such as “a rich man walked into our office and asked us what had been the lowest and highest prices of nickel. After telling him those prices, he said the current price was low and he placed an order.”
■ In a recent special report by China Central Television (CCTV), reporters visited Anxin County, the largest copper scrap trading hub in northern China. The reporters found many residents in the county have stockpiled some copper scraps in recent months, in quantities ranging from a few tonnes to a few hundred tonnes. In Wenzhou, in Zhejiang Province, the famously investment-savvy “Wenzhouees” are reportedly using large bank loans to stockpile copper scraps. A merchant told reporters that he has stockpiled 20,000 tonnes of scrap using bank loans. Local merchants said that it is very easy to get bank loans using base metals as collateral. In Guangzhou, CCTV reporters found that pig farmers are buying nickel or copper for stockpile. In addition to private entrepreneurs, it seems that institutional money, such as that from stock brokers and private funds, is also deeply involved in this “investment.”
■ We regard these speculative behaviours as natural, and they will inevitably occur in a bull market, so we do not want to exaggerate the impact they have. Also, the scale of the speculative investment is hard to quantify, although some local observers put the number at some 200,000 tonnes for copper, and at 50,000 tonnes for nickel. That said, we do want to caution that these stockpiles are in “weak hands,” as speculators have no real use for base metals. When the market sentiment turns, they are very likely to turn into quick sellers, especially when the bank’s money is involved.
■ As we said earlier, quantifying the scale of speculative stockpiling is an art, not a science. That said, we still can do some math for copper. In the first six months of the year, China’s apparent consumption for refined copper grew some 48%, or 1.2 million tonnes. China’s output of copper semis, which is a better gauge of real underlying copper consumption, was up about 14%. Using the semis output data, we estimate that China’s real refined copper consumption has grown by some 400,000 tonnes. The leaves some 800,000 tonnes of copper “consumption” to be explained by either stockpiling or other factors. We note that China’s copper scraps imports were down 40% in 1H/09, translating into a loss of copper content supply of about 350,000 tonnes. Assuming all the loss of scrap imports are compensated for by refined copper imports (which is not likely as concentrate imports were up 15.6%), this leaves “stockpiling” to explain 550,000 tonnes of apparent copper consumption. Further, we note that the Strategic Reserve Bureau (SRB) bought 235,000 tonnes of copper. So, commercial stockpiling and speculative stockpiling have to explain at least 300,000 to 350,000 tonnes of copper, if not more.
■ The same math can be done for nickel (where apparent consumption was up some 52.5% in 1H/09 while stainless steel output growth lagged badly) and for zinc (where apparent consumption was up some 21.7% in 1H/09 while coated sheet output was actually down 1.4% YOY in the same period).
■ Indeed, although some of the underlying sectors using base metals have registered impressive growth so far in 2009, the growth has not been as impressive as the apparent consumption for base metals. For example, in the first seven months of 2009, China’s auto output was up 20.7% YOY, computer output was up 14.6% YOY, television output was up 2% YOY, and refrigerator output was up 12.5% YOY. But in the same period, air conditioner output was down 16.7% YOY, and electricity generating machinery output was down 14.2% YOY. Battery output fell 12% YOY in July, reversing a 10% gain in June.
■ We are not listing this data to paint a bearish picture. Indeed, the Chinese economy is still recovering, and industrial output is now firmly up over 10% YOY. If the economic momentum is maintained, especially if home starts begin to pick up (as we discussed last week), most of the inventories could be easily digested in the real economy and the “investors” could be rewarded for their forward-looking bet. That said, if, for any reason, sentiment turns sour in the market, a temporary “de-stocking” could not be ruled out.
■ In addition to the high local inventory, in recent weeks we have been increasingly concerned about the supply-side response. In the next few sections, we review nickel, zinc, and molybdenum in this regard. As we have repeatedly mentioned in our recent reports, from a supply perspective, copper seems to be the tightest, and this explains our preference for copper over other base metals.
Zinc – More Output to Come
■ We notice that the treatment charges (TCs) for imported zinc concentrate have risen to US$160-US$170/tonne in July from below US$80-US$90/tonne in early March. Some local smelters said last week that overseas suppliers are now willing to accept TCs of US$190/tonne. Higher TCs show that concentrate availability is ample. Indeed, in the first six months of 2009, China’s zinc concentrate imports grew strongly by 48.7% YOY to 1.59 million tonnes. Thanks partially to readily available concentrate and high TCs, China’s refined zinc output grew 12.3% YOY last month, to a record high of 376,200 tonnes. Another factor that has contributed to the strong refined output growth is newly added capacity. We note that in July and August alone, at least 300,000 tonnes of new annual zinc smelting capacity (100,000 tonnes each from Zhongjin Lingnan Nonfemet, Xinan Copper and Zinc Smelting, and Hanzhong Zinc Industry) have already come on stream or are expected to do so.
■ With recent strong refined output and strong imports in recent months, we believe that there are at least 600,000 to 700,000 tonnes of zinc sitting in Chinese warehouses, equivalent to two months of Chinese consumption. These stocks include 115,731 tonnes at SHFE warehouses and the 159,000 tonnes held by the SRB.
Nickel – NPI is Back
■ In addition to the pickup of refined nickel output as we discussed last week, the production of nickel pig iron (NPI) is now back in top gear in China. Raw material is flooding into China, with ore imports jumping to 1.6 million tonnes in June. This was their highest level in 13 months, and July’s landings have been even larger, taking port stocks to a peak for the year at 8.6 million tonnes, according to Brook Hunt. With the industry’s production costs now in the US$11,000-US$17,000/tonne of Ni range, almost all operations, even those using Philippine ore, are economic, and output is racing ahead.
■ A recent survey by Brook Hunt’s Beijing office has identified 47 active, dormant, and greenfield ventures. There is active capacity for 145,000 tonnes per year (tpy) Ni, of which a little over half is based on blast furnaces, with the balance based on electric arc furnaces. About a third of this capacity is integrated with stainless mills, and the rest is independent. Next year will see even more potential, since expansions and greenfield projects will add 127,000 tpy of Ni to the industry’s capacity. Arguably, the capacity is almost limitless, since, in appropriate conditions, a vast range of ferroalloy furnaces could be pressed into service for the cause of NPI.
■ With no capacity constraints, there are few obstacles to NPI growth. In contrast to two years ago, the production processes are now well established, the product fully proven, and the end market clearly defined. How much NPI could be produced in 2009? By Brook Hunt’s estimate, there is little reason why output in the second half of the year shouldn’t be well up on the first half total of 37,000 tonnes, pointing to a total of at least 100,000 tonnes for 2009.
■ Our own research would concur with the basic findings of Brook Hunt, and in our opinion, as in the last nickel cycle, NPI production should cap the nickel price on the upside.
Molybdenum – Imports to Fall
■ As the steel market continues to correct in China, domestic molybdenum prices also suffered a small pullback last week. Ferro-molybdenum prices dropped slightly to around/below RMB180,000 per tonne.
■ For the time being, local Chinese prices are slightly lower than international prices, for both ferro-moly and molybdic oxide. As a result, quotations for Chinese exports are heard in the European markets again. Traders said that some trading houses have already delivered materials to local bonded warehouses and are ready to re-export molybdic oxide in the coming days. We understand small Chinese exports have already occurred in July and we should see them in the custom data to be announced later this month. Even if Chinese exports will likely remain modest in volume, we expect China’s molybdenum imports to fall visibly in the late summer months.
■ In recent weeks, we began to hear news about resumption of output by small producers in China. Although local prices have risen in sympathy with the overseas market, it seems that there is no real lack of material in China. The recent perceived shortages could be attributable to the fact that many producers and traders are hoarding material in anticipation of higher prices.
News in Brief
Fertilizer – Output Up Strongly
■ In July, China produced 5.733 million tonnes of urea, up 2.1% MOM and 21% YOY. In the same month, China produced 1.521 million tonnes of ammonium phosphate, up 1.6% MOM and 39.2% YOY. Potash output was 402,000 nutrient tonnes in the month, down 10.7% MOM but still up 31.6% YOY.
Grain – CNGOIC Sees Record Corn Output
■ China’s authoritative grain think tank, the China National Grains and Oils Information Center (CNGOIC), has raised its forecast for the country’s 2009 corn output by 2% to a record 166.5 million tonnes. The centre also upped its forecast for wheat output this year, which is now seen growing 2.7% to 115.5 million tonnes, rather than the previous estimate of 113.2 million tonnes.
Iron Ore – A Face-Saving Deal
■ Australia’s number three iron ore miner, Fortescue Metals Group, has agreed to supply China at a 3% discount to prices offered by its bigger rivals, in a deal that will allow the China Iron and Steel Association (CISA) to claim a partial victory in its quest for a better iron ore settlement. At 35% below the key Australian iron ore price last year, the price is better price than the 33% price cut offered by Rio Tinto to Japanese and other non-Chinese buyers. Fortescue offered the further discount partially to receive cheap Chinese financing for its iron ore capacity expansion.
■ We note that the deal, for 20 million tonnes of ore in the rest of 2009, will cover only a fraction of China’s iron ore imports, which are running at more than 50 million tonnes a month. Also, it is unclear whether Rio, BHP Billiton, and Vale will follow the move, although CISA said that it will negotiate with the three miners using the Fortescue prices as a reference. That said, the deal is still significant in that it will bolster Fortescue’s campaign to break into an iron ore market dominated by Rio, BHP, and Vale. If Rio, BHP, and Vale do follow the new price, the global seaborne iron ore market will have two benchmark contract prices – the Chinese price and non-Chinese price. And even if Rio, BHP, and Vale do not follow the new price, it will still become a separate price that smaller overseas suppliers might have to follow.
■ We note that the 35% price drop agreed to by Fortescue is exactly what we have been calling for over the past months for the 2009 iron ore contract price.
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 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, coking coal, uranium, molybdenum, DAP, and hardwood pulp sectors. We are neutral on aluminum, zinc, nickel, thermal coal, potash, 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 are now looking for a 35% drop in the 2009 annual iron ore contract. We expect the 2009 China potash contract price to drop US$151/tonne from its 2008 level, to US$425/tonne FOB.
Written by Na Liu of Scotia, published today: