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Msg  61876 of 65647  at  11/15/2009 9:33:03 AM  by


China Update

This was published by Na Liu on Nov 12.

China Update

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

Macro – De-stocking in a Strong Environment

Overnight, China released its October macroeconomic data and its output and preliminary trade data for key commodities. The data are fully in line with our macro themes since late summer: on the macro side, the economic recovery in China is still on the right track, led by the still-strong infrastructure investment, the ongoing construction boom in the housing sector, and a recent recovery of external demand for Chinese goods. On the commodity side, however, major commodities markets like steel, base metals, and chemicals are undergoing a “mini de-stocking” cycle, as China had over-imported in the first half of this year and Chinese domestic output has ramped up very strongly since summer. In short, the overall picture in China is that demand for commodities is robust, but at the same time supplies are ample – it is a de-stocking in a strong environment.

Strong Macroeconomic Readings

Last week, when reviewing the October PMI, we wrote: “With this level of manufacturing activities (PMI 55.2), China’s industrial production might well grow at over 15% YOY in October.” This prediction proved correct. Official data showed that all growth data are in line with or exceeding economists’ consensus. Industrial production climbed 16.1% YOY last month (consensus 15.5%), a 19-month high; fixed asset investment rose 33.1% YOY in the first 10 months of 2009 (consensus 33.5%); and retail sales jumped 16.2% in October (consensus 15.7%). We note that all these strong YOY growth data were partially helped by the low statistical base effects.

The monetary data are mixed. M2 money supply grew 29.4% YOY year-to-October, up from 29.3% YOY year-to-September. What disappointed the market is that in October, Chinese banks extended “only” RMB253 billion worth of loans, lower than the market consensus estimate of RMB370 billion. We note that although the total new yuan loan level is lower than expected, it is mainly due to a drop of bill financing and short-term loans; long-term loans actually increased a relatively healthy RMB411.4 billion (residential and commercial). In the first 10 months of 2009, total new yuan loans reached RMB8.92 trillion, far exceeding the RMB4.91 trillion total loan additions in all of 2008 and RMB3.63 trillion loan additions in 2007.

On the trade side, Chinese exports still dropped 13.8% YOY last month while imports declined 6.4% YOY, resulting in a higher-than-expected trade surplus of US$24 billion.

Inflation is still not a near-term concern. Both CPI and PPI remained in negative territory in October, down 0.5% YOY and 5.8% YOY, respectively.

We observe that this set of macroeconomic data is supportive for the global raw materials sectors, as it indicates the economic recovery in China is still in good shape, and near-term policy risk is not high due to still-mild inflation pressure.

Strong Supply-Side Response for Key Commodities

As for major commodities output data, our concerns about supply-side response have once again been confirmed. In October, China’s refined copper output grew 28.4% YOY and 1.1% MOM to a new record of 399,300 tonnes; aluminum output increased 17.1% YOY and 4.4% MOM to 1.26 million tonnes; refined nickel output increased 40.7% YOY but was down 6.6% MOM to 19,062 tonnes; and refined zinc output grew 9.8% YOY but dropped 1.2% MOM to 405,200 tonnes. We note that both refined copper output and primary aluminum output hit a record high for the second straight month.

On the bulk side, in October Chinese raw coal output grew 21.1% YOY and 3.8% MOM to 273.068 million tonnes; iron ore output jumped 18.4% YOY but dropped 1.4% MOM to 83.876 million tonnes; and crude steel output grew a massive 42.4% YOY and 2% MOM to 51.747 million tonnes. We note that raw coal, iron ore, and crude steel output in October represents the second-highest output levels for all three commodities. In addition, finished steel products output reached a fresh record of 62.449 million tonnes last month, up 41.6% YOY and 2.1% MOM. The massive output growth for steel products was led by rebar – its output grew 53.1% YOY and 7.1% MOM to 11.585 million tonnes.

On the oil side, October crude run increased 10.4% YOY and 1.4% MOM to a new record of 33.286 million tonnes.

Lower Imports for Everything, Except for Crude

With the massive imports since the beginning of the year and surging local production since the summer, supply in the local market is ample for most commodities, particularly base metals. As a result, Chinese imports for key commodities dropped sharply in October on a sequential basis. This is what we have called a “mini de-stocking” cycle. The good news is that this de-stocking cycle is happening in a strong macroeconomic environment, which supports underlying consumption.

Overnight customs data show that in October, China’s total copper imports (including semis)slumped to 263,109 tonnes from 399,052 tonnes in September; copper scrap imports declined to 260,000 tonnes from 406,477 tonnes; unwrought aluminum imports dropped to 86,611 tonnes from 195,877 tonnes; iron ore imports declined to 45.47 million tonnes from 64.55 million tonnes; and soybean imports moderated to a one-year low of 2.52 million tonnes from 2.75 million tonnes.

The only bright spot on the import side is crude oil. In October, China imported 19.34 million tonnes of crude compared with 17.2 million tonnes in September, and up 19.7% YOY. Strong crude oil imports, together with the record crude run as discussed in the output section, paint a picture of firmer local demand. Earlier this week, the President of Sinopec, Asia’s largest refiner, said he is “very confident” that China’s appetite for oil will accelerate in 2010, with demand growth for refined fuel expected to hit 8%, up from an estimated 3% in 2009.

Copper vs. Iron Ore

We note that although copper and iron ore imports were both down about 30% MOM in October, the effects on the market are different. For copper, overall inventory remained high and de-stocking will likely continue in the next few months. We note that in the past two months, the bonded warehouses in Shanghai are “getting full”. Local market participants estimate that some 300,000 tonnes of copper are stored in bonded warehouses now. In past years, the normal level for bonded materials was in the range of 30,000 tonnes to 70,000 tonnes.

For iron ore, however, local inventory has already been drawn down due to lower imports in October and, more importantly, the still-strong steel output rate. In fact, since early September, iron ore inventory at main Chinese ports has declined about 9 million tonnes or 11.6%. As we write in the output section, Chinese crude steel output grew a massive 42.4% YOY and 2% MOM in October to 51.747 million tonnes. The strong steel output has put pressure on ore supply. In the spot market, Indian ore of 63%/63.5% iron content has firmly topped US$100/tonne this week, with some miners asking over US$105/tonne. In addition to high steel production, worries about supplies from India and lack of spare capacity in Western Australia also support spot iron ore pricing. An Indian official said the government of the eastern Indian state of Orissa would inspect several iron ore mines in a crackdown on firms infringing mining or environmental rules.

The only concern for the iron ore market now is the lagging steel pricing. Although the sharply higher iron ore prices, together with the strong demand from the property sector, have gradually pushed steel prices higher in China since early October, the record high steel production in recent months is preventing the market from seeing any price spikes. Unlike iron ore, the current inventory for steel products remained on the high side, indicating local supply is readily available. Compared to iron ore, the recent rally of steel prices in China is much more modest. Since the recent lows, the iron ore price has rallied at least 30% and steel prices have only gone up about 7% (rebar) to 10% (HRC). The lagging steel price has put pressure on the steel mills’ margins and may eventually hurt their incentive to maintain high output rates and, in turn, high ore purchases.

Property – Strong Home Sales and Home Construction

Property sales remained strong in China in October. Total area sold rose 81.8% YOY to 79.98 million m2. New area under construction remained strong in the same month at 108 million m2, up 48.8% YOY.

As for leading indicators, land acquisition amounted to 26.2 million m2 in October, up 27% YOY and land development area rose 19.9% YOY to 17.39 million m2, while new start-ups grew 54.6% YOY to 82 million m2.

We view the October data from the property sector as supportive of our view that a construction boom in the Chinese property market is ongoing. This construction boom should eventually trigger a second leg for Chinese raw materials demand next spring when the ongoing mini de-stocking cycle finishes.

Auto – Sales Still Strong in October

China’s passenger cars sales surged 75.8% YOY but declined 6.8% MOM to 946,400 units in October. Overall vehicle sales, from trucks to buses, jumped 72.5% YOY but dropped 7.5% MOM to 1.23 million units in October.

In the first 10 months of 2009, a total of 8.19 million passenger cars were sold in the country, up 45.18% YOY, exceeding a total of 6.76 million units sold in the whole of 2008. Overall vehicle sales rose 37.71% YOY to 10.89 million units from January to October this year, compared with last year’s total of 9.38 million units.

Industry observers had expected the market to slow next year if the government opts not to renew the policy incentives, which will expire by the end of this year. The good news is that a report by China’s Ministry of Industry and Information Technology indicated last week that the government might extend some of the existing incentives, including cuts in sales tax for small cars, as well as introduce other steps.

Overall Observations

So far this year, China’s macroeconomic data and commodities import flow have largely been disconnected. In early 2009, official economic data was weak, but China became dominant importers for almost all major commodities. The imports in early 2009 were driven by the stimulus package, re-stocking demands, and lower domestic output due to low commodity prices. But recently, in contrast, China’s macroeconomic data has picked up strongly, but imports have lagged, as China over-imported in the early part of 2009 and local commodity output has surged to record highs after the summer due to stronger commodity prices.

We expect the ongoing mini de-stocking cycle to last into February 2010, as very soon China will enter the harsh winter season in the North and the Spring Festival season in early 2010, neither of which will be good for construction activities. We expect China’s commodity imports to come back strongly in the spring of 2010, when de-stocking comes to an end and normal construction season begins.

News in Brief

Oil – The Pricing Mechanism

On Monday, China raised retail gasoline and diesel prices by RMB480 (US$70.32) per tonne. Although the hike was widely expected, its magnitude is higher than the market expectation of RMB350/tonne. This move has pushed diesel and gasoline prices to record levels in China.

It is unclear what the government will do if the crude oil price rallies over US$80/barrel for a sustainable period. Under the year-old pricing mechanism, Beijing may change fuel prices when a 22-day moving average crude price moves more than 4%, as long as the international crude oil price is below US$80/barrel. When changing prices, the government will ensure a “normal refining margin” and align domestic fuel prices with international crude oil costs.

Industry observers have been speculating in the past year on what will happen if the crude cost is over US$80/barrel. A recent Reuters report might shed some light on this. The report quoted “a senior industry analyst with knowledge of the pricing regime” as saying that if crude oil is below US$80/barrel, the normal refining margin is set at 5% of the corresponding crude cost. As crude moves from US$80/barrel to US$105/barrel, the margin will be lowered proportionately to 0% from 5%. When crude is between US$105/barrel and US$130/barrel, refining margins will remain at zero, but retail fuel prices should still reflect crude costs, said the analyst, who declined to be named due to the sensitivity of the issue. When crude rises above US$130/barrel, fuel prices will be decoupled from global crude costs and the government will use tax incentives or subsidies to encourage oil firms to keep producing fuel, he added.

Coal – Heavy Snow Hit Shanxi Province

Thousands of vehicles have been trapped on roads after two days of snow in China’s biggest coal-mining province, disrupting the movement of people and coal, state media reported on Wednesday. Some 10,000 vehicles and 30,000 people were stranded in the northern province of Shanxi by the snow, which began on Monday. Places across the province hit by the jams include Datong, Changzhi, and other big coal-mining centres. But there were no signs yet that the supply disruptions have seriously hurt power or industrial production.

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:

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, corn, DAP, and hardwood pulp sectors. We are neutral on aluminum, zinc, nickel, thermal coal, potash, urea, wheat, soybeans, 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 looking for a 12.5% increase in the 2010 annual iron ore contract. We expect the 2010 benchmark Australian hard coking coal price to settle at US$160/tonne, up from US$129/tonne in 2009. We expect the 2010 China potash contract price to drop US$181/tonne from its 2008 level to US$395/tonne FOB.

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