Today's update from Na Liu of Scotia:
China Commodities Weekly for
the Week of February 1-February 5, 2010
■ This week, China's nickel and DAP prices were up;
iron ore, steel, urea, potash, chemicals, and oil product prices were flat; and
copper, aluminum, zinc, grains, and coal prices were down.
Macro – The Collective
Wisdom of a Market
The Two Finishing Lines
the beginning of 2009, the performance of the Chinese stock market has been
fascinating in two major aspects: its overall performance and its sector
the overall performance side, it is fair to say that in the first half of 2009,
the Shanghai market led the global equity market rally. In fact, one can argue
that the Shanghai Composite Index, which peaked in October 2007 and bottomed in
November 2008, had led the S&P 500 Index on all the major market turning
points in the past three years. This is why the fact that the Shanghai market
peaked on August 4, 2009, has worried many bulls in the global raw materials
if the bulls look at the underlying sector behaviour in the Shanghai market,
their worry would grow further. The materials sector finished first (up 141%
since January 2009), followed by energy (up 131%), then by property (up 121%), and
by financials (up 109%). The consumer discretionary, IT, and industrials sectors
are the key laggards. This result might seem intuitively right to Western
observers. In many investors’ minds, Chinese growth was driven by a simple
fact: huge loan growth has supported a huge construction boom in the
infrastructure and housing sectors, so the materials, energy, financials, and
real estate property sectors should outperform.
■ However, this situation was totally reversed in the
following five months. At the second “finishing line,” on January 29, 2010, the
consumer discretionary and IT sectors finished in first and second place, while
the materials and energy sectors suffered a major pullback, financials and
property sectors dropped even further, and industrials still finished last. Indeed,
the pullback for the materials, energy, financials, and property sectors since December
2009 has been very drastic.
The Collective Wisdom of
■ Recent history tells us that we should not totally
dismiss the collective wisdom of the Chinese investment communities. It is undeniable that in the past few months, local
Chinese investors lost faith in the financials sector over concerns about the sustainability
of easy credit growth; they also lost faith in the property sector over concerns
about the sustainability of strong home sales and an “asset bubble”, and they lost
faith in the materials and energy sectors over concerns about the
sustainability of the construction boom, which was driven by easy credit and
strong home sales.
■ And in contrast to the Western perception that the
Chinese economy is all about construction rather than consumption, in the past
few months Chinese investors have put their money into consumption sectors such
as consumer products, electronics, autos, tourism, and information technology.
■ We would refrain from drawing major conclusions
based on a few months of market performance. Indeed, if our call for a major
construction boom in the spring materializes, the sector rotation might well
reverse back again in favour of materials and energy. That said, we would at
least take notice of what the local market is telling us.
More Loan Restriction News
on January 12, in an interview with The Globe and Mail,
we commented on the RMB600 billion in new loans in the first week of January by
stating: “Superficially, it is very bullish because it shows liquidity is ample
in China but that could draw the attention of the central bank that may decide
to do something to stop it.” Indeed, the Chinese authorities have not only done
something to stop it, they have done a lot since mid-January.
February, after a lending pause in late January, Chinese commercial banks have resumed
their lending to clients. But both local media reports and bank sources indicate
that the renewed lending is now subject to some “soft restrictions.” For
example, local financial media CBN said yesterday that “loans to developers
will be temporarily tightened, according to sources from several commercial
banks.” The 21st Century Business
Herald, another local newspaper, reported that
Chinese banking authorities have asked commercial banks to carefully review and
strictly control loans to the steel industry and steel traders, because of perceived
high inventory risk and overcapacity concerns. We also understand that the Bank
of China has officially terminated the 30% interest discount for personal
mortgage loans. The best interest rate offered by the bank to first-time home
buyers is now a 15% discount on the benchmark lending rate.
21st Century Business Herald also said that the government has set a sector-wide
ceiling of RMB2.4 trillion in new loans for the first quarter. That would be
about one-third of the full-year target of RMB7.5 trillion. Also, the newspaper
said that authorities have allocated full-year loan quotas to each of the
country’s biggest banks. This is contrary to the official comments by the China
Banking Regulatory Commission. Last month, the commission denied that it was
implementing bank-specific loan quotas.
the increased policy risk and signals from the Chinese equity market, we choose
to remain a seasonal bear, despite the recent pullback in global raw materials
sectors. We will watch the situation closely on the post-Spring Festival market
behaviour to determine our short-term, seasonal views. We remain a cyclical and
secular bull for the time being.
Commodities – Fertilizer
week, we upgraded our view on potash and urea to “positive” from “neutral,” and
stressed that DAP remains our preferred play. We also downgraded our view on
the steel sector. The developments so far this week strongly support these
Fertilizer – The
note that Belarusian Potash Co. said this week that it has raised potash prices
by US$25/tonne to benefit from a recovery in demand, bringing the price in Asia
to US$410/tonne on a C&F basis. Separately, the Fertilizer Monthly Bulletin said that there has also been a “huge” surge in
demand from Brazil, Europe, and some Asian markets since BPC agreed to a
US$350/tonne sale to China in December.
the DAP and urea side, we note that since the beginning of February, China’s
export tax has been raised to 110% from 7%, as the country enters planting
the fertilizer sector as a whole, we would like to observe that this is a
sector where the equity market sold off when physical commodities rallied in
January, particularly DAP, and now potash. This is a rare divergence – other
sectors, such as copper and steel, are facing a symmetric pullback in both
physical commodity prices and related equities.
Steel – The Loan
we wrote in the Macro section, the 21st Century
Business Herald, a respected local newspaper,
reported on Wednesday that Chinese banking authorities have asked commercial banks
to carefully review and strictly control loans to the steel industry and steel
traders, because of the perceived high inventory risk and overcapacity
concerns. The paper wrote that all commercial banks in Sichuan province had
received an internal document from the Sichuan bureau of the China Banking
Regulatory Commission. The document, dated January 25, 2010, said that all
financial institutions should review outstanding loans to the steel industry
and control risks accordingly. The risk is high in the steel industry because “steel mills and steel traders, with the support of
bank credit, are betting on higher steel prices in 2010 as a group by
stockpiling. The steel inventory level in the country has swelled and risk has
accumulated.” The document said that at
the end of 2009, the total steel inventory
in China was 70 million-80 million tonnes, up by about 20 million-30 million tonnes
on a YOY basis. As total steel output in 2010 is likely to top 700 million
tonnes, the high inventory and strong output will put pressure on steel prices,
according to the document. The document also said that if steel prices go
lower, banks will face “severe financial risks.”
■ We observe that in China, many steel traders use
bank loans to facilitate trade. A common practice is to secure bank loans using
steel inventory as collateral. For collateral purpose the steel inventory is
usually valued at 65%-70% of market value by the banks. If the banks want to
tighten loans to steel traders, they can lower this collateral ratio from
65%-70% to, say, 55%. Also, as steel prices have dropped in January, the banks
can also mark-to-market the value of steel inventory held as collateral. All
these moves can force traders to sell some inventory to pay back some bank
loans. If this happened on a large scale (not yet), it could start a
de-stocking cycle in the market.
■ As we have written repeatedly, we still believe
that construction activities will come back strongly in the spring after the
seasonally slow winter and spring festival. The only risk that concerns us is inventory
levels. Local traders have built inventories counter seasonally so far in the
winter months in anticipation of stronger demand and higher prices in the
spring. A de-stocking in the rest of the winter is therefore very desirable.
Otherwise, the country will face sufficiently high inventory for key
commodities in the spring, when construction eventually starts. This would undermine
the bullish case for the spring rally that we foresee.
■ Investors who like the overall construction theme
in China should continue to put their money in the iron ore and coking coal sectors,
in our opinion. We note that iron ore prices rose slightly in the past few days
after the recent pullback, and coking coal prices were slightly higher in major
producing areas last week.
Oil – CNPC’s Forecast for
■ China’s crude throughput will grow 5.1% YOY this
year to keep pace with oil demand, which is set for expansion at a similar
pace, state-run top energy group CNPC said in an annual research report.
■ The run increase, equivalent to about 380,000
barrels per day (bpd), compares to a Reuters poll
China’s top 22 oil plants would add 560,000 bpd crude throughput this year.
■ CNPC expects China’s crude oil imports to increase
9.1% YOY to 212 million tonnes in 2010, or 4.24 million bpd. The forecast,
however, was not consistent with the 2009 base figure released by China’s
Customs department that showed China imported 203.79 million tonnes or 4.07
million bpd of crude last year. Net oil imports, including crude and refined
oil products, could rise 8.3% to 234 million tonnes.
■ China’s apparent oil demand will grow more than 5%
to 427 million tonnes this year, or 8.54 million bpd, CNPC said.
■ The country is expected to add 31.5 million tonnes
of crude refining capacity in 2010, raising overall capacity to 10.3 million
bpd by year-end, according to the report compiled by CNPC’s Research Institute
of Economics and Technology.
■ Domestic crude production will gain some 2% to 193
million tonnes, while gas output is expected to rise to nearly 100 billion
cubic metres (Bcm), CNPC said, an amount some 20% above last year’s level.
China’s crude output inched down 0.4% to 189.5 million tonnes in 2009 and gas
output gained 7.7% to 83 Bcm during the same period, data from the National Bureau
of Statistics showed.
■ Ethylene production capacity is expected to
increase by 2.57 million tonnes from a year earlier to 15.27 million tonnes by
the end of this year, and actual output could top 12 million tonnes, the CNPC
■ Natural gas imports will top 10 Bcm in 2010, the
Recap Of Our Calls
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
■ 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 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, iron ore, thermal coal, coking coal, uranium,
molybdenum, corn, DAP, urea, potash, and hardwood pulp sectors. We are neutral
on aluminum, zinc, nickel, steel, 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 China perspective.
■ Views on annual contract negotiations: We are looking for a 25% rise in the 2010 annual iron
ore contract. We expect the 2010 benchmark Australian hard coking coal price to
settle at US$185/tonne, up from US$129/tonne in 2009.