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Mining and Forestry
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China UpdateWe just return to Hong Kong, so I am doing a belated post on the updates.
Macro – The Three Economic Trends ■ As we have reiterated in
our “Recap of Our Calls” section every week, we believe that 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). Before this note, we called ourselves a seasonal bull, a
cyclical bear, and a secular bull. Beginning with this note, we are calling
ourselves a seasonal bear, a cyclical bull, and a secular bull. Near-Term Seasonality: Harsh Winter and ■ As we wrote last week, ■ We note that the raw
materials sectors have rallied hard since late March without any serious pullback
(and our recommendation has been “overweight” all the way along). If any deep pullback
in the raw materials sectors were to happen in the next few months, we believe
it would most likely happen sometime in January-February 2010. This is because
as construction activities have been slowing down earlier than expected due to
the harsh weather, the “mini destocking cycle” for most commodities, especially
for base metals, likely will last until the end of February. During this
period, slower Chinese imports, together with sluggish local demand, could
dampen investors’ sentiment after this year’s huge rally in the raw materials
sectors and trigger some profit taking. ■ If investors decided to
take some profit in early 2010, we believe, as we argue below, that this could
become a very good buying opportunity for a potentially powerful rally in the spring
of 2010, when Chinese construction activities come back and the de-stocking
comes to an end. When Spring
Comes, Construction Activities Could Power Ahead ■ The overall construction
level in ■ We understand that some
investors have the concern that infrastructure construction might wear off next
year and offset any strength in the housing sector. We do not share this
concern. In fact, we expect, just like with home construction, that infrastructure
construction also resume at a very high level next spring. ■ Almost exactly one year
ago, on ■ According to the NBS, in
the first 10 months of 2009, 293,412 new projects broke ground, with a total
planned investment of RMB12.46 trillion, up 81.1% year over year (YOY). Offsetting
some projects that were finished in the same period, the number of new projects
pushed the total tally of projects under construction to 402,204. As at October
2009, the amount of funds needed to complete these 402,204 projects under
construction reached RMB37.6 trillion (or 1.2 times Chinese 2008 GDP), up
RMB10.07 trillion or 36.6% YOY. This shows that even without any new projects launched next year,
just the completion of ongoing projects
requires a hefty amount of additional investment and continued construction
efforts next year and beyond. ■ In terms of timing, we note
that many infrastructure projects launched in 2009 under the stimulus package
are multiple-year projects. For example, investment in railroads is expected to
peak in 2012, according to a study by KPMG. Of the 16,000 kilometres of new
high-speed rail
to be laid by 2020, 13,000 should be completed by 2012. Another example is the construction
of nuclear reactors. Since late 2008, more than 15 new reactors have started construction,
which will last at least three years. In our opinion, the peak in stimulus investment
and project construction will not come until mid-2010. So far this year, most long-term
projects have just finished their land preparation work, such as relocating
residents and geographic testing. Credit Has to Remain Ample… ■ With so many investment
projects to be completed, we believe that Chinese loan growth will have to
remain at a very high level next year, say over RMB7 trillion. Historical data
shows that about 20% of fixed asset investment was financed by new bank loans
and this year it has been as high as 30%. Therefore, to finish these projects
under construction (valued at RMB37.6 trillion as mentioned above) in three
years, we believe bank loans will have to grow about RMB11 trillion in the same
period, or RMB3.67 trillion per year. To put this in context, RMB3.67 trillion
is in fact equal to total loan additions in 2007. Also, RMB3.67 trillion is
only slightly smaller than this year’s non-residential long-term loans: among
the RMB8.67 trillion new loan additions in the first three quarters of 2009,
RMB4.3 trillion, or about 50%, are non-residential long-term loans, loans that
fund infrastructure projects. Therefore, if ■ To put it this way, the
real monetary policy (rather than rhetoric) will have to remain loose in the
next two years if the central and local governments want to finish the projects
launched in 2009 and avoid immediate bad loans on the Chinese banks’ balance sheets.
In a sense, the monetary policy in the next
two years has been hijacked by the massive project launches in 2009. And as is usually the case
in …And Credit Can Remain Ample ■ We know that at this stage,
our readers might have two questions: First, if loan growth has to remain high
next year, can the Chinese system support it? And second, will the sustained
high loan growth prove detrimental to the Chinese economy in the longer term?
To the first question, our answer is yes – the Chinese banking system can
continue to leverage up. To the second question, our answer is that we are not
sure it will become detrimental, even in the longer term. ■ So far this year, the
Chinese banking system has been able to sharply increase its new lending while
meeting the reserverequirements. In fact, the central bank (PBOC) reduced the
bank reserve ratio only three times since late 2008, and for the time being,
the required reserve ratio has remained at a lofty level. In the past three
years, it proved a much easier job for the PBOC to loosen (three steps) than to
tighten (19 steps). And the reason for this is very simple: Chinese banks have a
vast deposit base to draw upon as the deposit growth has exceeded the loan
growth in ■ To understand why this
happened, we have to review some basic economics. As in other mature economies,
in A Milestone for
Leveraging Up? ■ This leads us to the answer
to the second question we cited – will the massive construction boom and
sustained loan growth prove detrimental to the Chinese economy in the longer
term? Not necessarily, insofar as they will also lead to stronger domestic consumption.
We know that many observers view the huge loan growth this year as a time bomb
in the future. These “ ■ To understand this point,
investors need only to look at the history of the over-leveraged
like in the Conclusions ■ With this note, it is fair
to say that we are getting more constructive in the medium term. We think
benchmark-driven investors should remain overweight the raw materials sectors. “Quick
money” or absolute return-driven investors may consider taking some profits
after the “Santa Claus” rally, if any; but just to remember to buy back long
positions after any potential pullback and stay long into next spring. Commodities – The
Heavy Snow in ■ Heavy snow continues to hit
some parts of ■ Earlier this week, the
official Xinhua News Agency tried to downplay the snow’s impact on coal supply.
An official from the State Grid Corp., which provides electricity to 88% of the
country, told Xinhua that “coal stocks are nothing to worry about … All 541
power plants connected to the State Grid have reasonable coal stock levels....
The crucial thing is the follow-up refill, which depends highly on
transportation.” Also, daily coal throughput at ■ As to other commodities,
the snow is potentially bearish for wheat. Heavy snow cover would protect the
winter wheat in major producing areas from winter-kill and would provide ample moisture
next spring. ■ We noticed the media
reports that the snow is cited as a major factor for the upward moves in zinc
and copper prices. These reports said that the snow could hurt local supply of
both metals. We believe that the reports ignored the demand side of the
equation. The heavy snow has made the winter come early in News in Brief Oil – Fuel
Stocks Dropped Again ■ Fuel stocks held by ■ Though the drop in refined
fuel inventories could be partly due to a wave of stock building aiming to beat
an overdue oil price rise, it is in line with a series of signs of a more solid
recovery in the Chinese economy. “It is true that the economic recovery is
gathering momentum, that’s evident from the sizeable drop in diesel stocks,”
the source said. Gasoline stocks rose 1.6% while diesel dropped 10.1% last
month, according to the Reuters source. ■ Sales of the two fuels
increased during the month. Gasoline sales rose 3.7% in October to about 5.8
million tonnes, while diesel sales rose 2.2% to 12.4 million tonnes, the source
said. Grain –
Stockpiling Price Policy ■ ■ Corn procurement prices
were unchanged at last year’s RMB1,500 per tonne, with subsidies of
RMB50-RMB100 offered to large feed mills in six provinces in southern Coking Coal – Coke Export Tax to Stay ■ Recap of Our Calls ■ Essentially, we are making
four calls in our China Commodities Weekly: economic trends in ■ 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 bear, a cyclical bull, and a secular bull. ■ Overall sector call: Our overall sector call is to answer one question: purely from a ■ 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, 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 ■ Views on annual contract negotiations: We are looking for a 12.5%
rise 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 |
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