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Apr 2013 - Commodity Prices

Commodity Prices have to be weak in 2013 !

....or at least that seemed to be the message that had been given to Chinese presenters ahead of last years' China Mining Conference in Tianjin in November 2012. Basically the Western presenters were relatively bullish, while the Chinese presenters were bearish about the prospects for most commodities during 2013.

The closing remarks by the Joint Chairman in the iron ore session were a  classic. Initially summed up by the Chinese Chairman that the iron ore price was expected to fall during 2013 due to weak European demand and the US fiscal cliff, possibly dropping back to the low levels that it had reached in 2012.

This was followed by the Western Chairman stating that he disagreed with his learned colleague, "we (CRU) think that Europe is gradually turning upwards and that the US bottomed in the 3rd Qtr of 2012, and hence expect iron ore prices to be relatively stable during 2013", (if anything CRU were cautiously optimistic).

Which was then followed by the Chinese Chairman, insisting that my (CRU) colleague's view is incorrect, our view is correct,  iron ore prices are going to be weak during 2013 ! (And there you have it by "royal" command !).

It was stated by one of the presenters that "commodity prices are high due to our (China's) demand, why should we (China) have to pay high commodity prices for our own demand ?". Which could be taken to infer that expectations may be dampened in order to acquire commodities at lower prices.

Late last year, some figures were released which showed that by the end of October 2012, China had imported 607mt of iron ore during the first 10 months' of 2012, being up 8.9% y-o-y, so why did that price collapse occur ? China clearly imported "big time" when the iron ore price dropped to its lows. Iron ore producers kept stating we are not seeing any slowdown in demand for our products - and they were right, even as the iron ore price was falling to lows.

It was also stated in the conference that China has been given two "gifts" so far to acquire commodity deposits cheaply, namely the GFC and the current European crisis. Whereas the Western world viewed them as "calamities", China viewed them as "opportunities".

On the subject of iron ore, it was puzzling that in at least the short-term, steel demand was expected to increase during 2013 with no upward price impact on commodities. In fact, iron ore demand was expected to increase to possibly1.25bt to 1.5bt from 2015 to 2020, with imports into China peaking at ~700mt. Which all sounds relatively bullish, except that China expected to be supplying ~60% of its iron ore from its own mines (~400mt in China) and  overseas.

China's own overseas mine component was expected to gradually rise during 2015 to 2020 as its own mines in Africa are commissioned, sourcing less from Australia and Brazil. Although some people have stated that such targets are too ambitious, (mostly due to infrastructure and politics in Africa - except that China has achieved significant construction projects within record times in China).  Consequently, Australian iron ore producers should perhaps diversify their iron ore sales/contracts and cautiously be increasingly less reliant on future demand from China for their products.

It was shown in a presentation that Sinosteel have a JV with RIO and 9.6bt of iron ore out of China's 38.6bg of overseas/external iron ore reserves.

Chinese commodity demand is certainly there as we saw in the construction of bridges, apartment blocks, duplicate second upper level ring roads (Chengdu), metros and bullet trains in our subsequent visit to Tianjin, Chengdu and Chongqing.

Chengdu has 4 metro lines under construction, as does Beijing, Chongqing and Tianjin, bullet train lines are under construction and in operation criss-crossing China and linking to other countries. Chongqing has at least 5 (that we saw) bridges under construction over its rivers and valleys as shown in Figure 1, and 20 to 28-storey apartment blocks are gradually replacing the older apartments, following a study which showed that it is more environmentally efficient to have such high-rise buildings (although there are also some areas of blocks of 2-storey houses).

The Beijing metro map shows a plan for ~15 underground lines, having grown from 4 in 2007 about 9 lines have been added for the current 13 lines in only 5 years !, during which time Sydney is still debating the merits of having another line. However, China does have the benefit of numbers, ridership on the Beijing subway is ~7.6mn per day or 2.2bn in 2011, which is why the cost of any trip regardless of length is still only Rmb2 (A$0.30).

The share markets were weak overseas on Monday 4 March 2013 apparently on the back of ...wait for it...."China slowing down" . What, again we thought !  How many times can you cry "wolf" before you are ignored ?

But yet, reviewing the China Daily over the previous few days, there was nothing saying or indicating slowdown. There was weakness in listed property companies because the tax on selling properties has been proposed to be increased from 1% to 20% (which is not quite true as there was an option since 2010 to pay 20% of the capital gains tax or 1% of the property's value - the 1% option is being removed).

HSBC gave a growth forecast of 8.6% for China in 2013 (which is well above the IMF's 8.2%) - after the 7.8% achieved last year, and the 7.5% target for the coming year.

China's GDP growth rate appears to be a case of "pick a figure" as it is an average across the country, with some parts of China significantly higher than others, for example, the highest in 2011 appears to have been Chongqing  @ 16.5% [collective pop: 33mn],  Tianjin @ 16%; Sichuan (includes Chengdu [pop:15mn]), Guizhou and Yunnan @ 15%; and then Shandong & Zhejiang @ 14%.

China's GDP increased from $1.45trn in 2002, to $7.32trn in 2011 (with a target of 28% of world GDP in 2030), while the world's GDP apparently increased from $43trn to $69trn, Tianjin increased from $26bn in 2002 to $175bn in 2011, with Shandong's GDP now at ~$650bn & Zhejiang's GDP ~$500bn.

After all, with a base of $7.32trn in 2011, 7.8% growth in 2012 an possibly 8.2% growth in 2013, the same result of $8.54trn can be achieved from 8%pa in both 2012 and 2013.

With such wealth generation, it can be understood why the EU and the US have been calling on China to increasingly invest and reduce Europe's deepening recession as European businesses increase their investments in China where growth prospects are stronger. In 2012, there were ~40 M&A deals valued at $11.1bn involving Chinese Companies in the US, with the remaining $20bn of the $32.1bn spent in North America (according to KPMG) being on 22 deals in Canada.

The China Mining conference covered a number of other metals and minerals. For Copper, CRU thought that China was facing an increasing import requirement to feed its smelters, although it was sourcing less copper con from South America. China Non-Ferrous cited imports as being 1.6mt in copper-gold ores plus 1.2mt in copper waste/scrap for 63% imported to achieve China's 4.5mtpa of copper production.

With new mines coming into production, the copper price (currently ~$8000 ($3.63/lb) was perceived as being capped to some degree at ~$10,000/lb or $4.53/lb, and so in the medium term (2017 !) copper was expected to gradually slip to ~$6000 ($2.72/lb). CRU were more bullish on zinc due to mine closures despite expected increased domestic mine production, but thought it was unclear as to how much could be offset by possible new mines starting in Australia and Canada.

Despite the speculative element, nickel was regarded as a non-event due to by-production from nickel pig-iron (with Chinese companies investing in Indonesia to meet legislation requirements) and major nickel laterite plants gradually being commissioned (even allowing for delays).

CRU thought that the 1H 2013 could be in balance and may average ~$17,800/t (~$8/lb) for 2013. It was considered possible for nickel to rise to ~$23,500/t (~$10.60/lb) by 2015 but new projects were then expected to bring the price back down again.

The uranium session was surprisingly bullish with the long-term contract price relatively stable but share prices dependent on the spot price recovering. However, China expected to satisfy 50% of its requirements from its own mines including the new discovery in Inner Mongolia, with the remaining 50% coming from targeted acquisitions in Australia, Africa and Central Asia.

China's nuclear power plant construction was in temporary slowdown as all new construction was suspended after Fukushima, only those in construction were allowed to continue. New approvals were expected after 2016 as ~70% of China's energy comes from coal with only 1.8% from nuclear compared to nuclear-friendly countries sourcing ~14% of their energy from nuclear.

The theme of the conference appeared to be pushing the view of a weak commodity price outlook despite continued growth in China, with China trying to buy its commodity requirements for as low a cost as possible through overseas acquisitions adding to its domestic production, or other means.

Interestingly the industrial stocks have been rising on the improved potentially recovering economic outlook for the US and Europe, but are not expected to have any effect on commodity demand, or commodity prices.

The key driver is still perceived to be China with its targeted growth of >7.5%pa for the next 5, 10 or 15 years, consequently, care has to be taken not to overreact when comments are made regarding "China slowing down", although the market may have to pass through its own learning curve.

Disclosure and Disclaimer : This article has been written by Keith Goode, the Managing Director of Eagle Research Advisory Pty Ltd, (an independent research company) who is a Financial Services Representative with Taylor Collison Ltd.

Figure 1. Bridge Construction for road and rail over the River Yangtze in Chongqing

  • Written by: Keith Goode
  • Monday, 01 April 2013