Global Outlook

China's ambitious plans are likely to drive the demand for industrial metals

By Nirmal Bang

 

Every time we talk about base metals, the first thing that comes to our mind is China. China has been the fastest growing economy in the world in almost three decades and is now the third largest economy. Since the start of the year 2000, Chinese growth engines have gained steam and it seems they are showing no signs of waning. This can be attributed to the government’s strong will.

 

Due to the credit crisis and the financial meltdown that hit the globe, the worst since the Great Depression of 1930, the prices of base metals saw a steep crash last year. Most base metals were trading at their multi-year lows and buying support was not evident in any of them. Abnormal time requires abnormal measures to come out of it.

 

Interestingly, some base metals were even trading below their cost of production for a good amount of time. But buying interest was not evident until the Chinese government stepped in to endow support in an effort to stabilize industrial metal prices.

 

The Chinese State Reserve Bureau started buying base metals for their strategic reserves, to make the most of low prices and to support local miners and smelters. The Chinese government has stocked more than 1.5% of the global consumption of aluminium, copper and zinc. In case of lead, it has stocked more than 5% of the global consumption and more than 4% of the global consumption in nickel.

 

This massive restocking activity has sucked out a huge surplus from the market. The government of China flooded their markets with a stimulus package of $585 billion to boost infrastructure spending and to push domestic consumption. Imports of base metals jumped sharply in the first three quarters of 2009, which triggered a major upside in prices.

 

 

Lead

Lead has been one the top performers in the base metal complex, rising by nearly 140% as environmental issues at Doe Run, the largest lead producer, as well as lead poisoning in China, have led to supply concerns, whereas the demand from batteries which constitutes 81% of the total global demand for lead, has been robust as auto sales in China and other emerging markets have been growing rapidly.

 

 

Copper

Copper, the king of base metals, rose by nearly 120%. Robust demand from China and supply concerns at Chile can be attributed to this upside. However, investment demand in copper has been robust post March ’09.

 

 

Zinc

Nearly 47% of demand for zinc comes from galvanizing of steel and Chinese production of steel has been robust since the start of the year. Production cuts and China’s aggressive buying have lent support to zinc prices in the first two quarters.

 

The accident that occurred in the world’s second largest zinc mine, Century Zinc Mine, Australia led to a drop in the production of zinc concentrate by two thirds to around 10,000 tonnes.

 

The 304-kilometre (190-mile) pipeline carrying wet concentrate from the mine to a storage shed in the Port of Karumba burst on 5th October, preventing the flow of the material. This triggered a sharp upside in zinc futures during October ’09.

 

Nickel

In the last quarter of the year 2008, nickel prices were seen trading in the range of $1.5 - $2/kg, below the cost of production for a lot of miners in Australia. Finally, value buying emerged, which led to a sharp upside in nickel futures. But the markets corrected sharply after touching Rs 1,000/kg as 45% of the total nickel demand comes from USA and Europe, where we have not seen any major recovery in the demand for stainless steel.

Due to this, several mills remained closed. Nearly 65% of the demand for nickel comes from the stainless steel industry. There has been a positive growth in the demand for stainless steel in China. But since the last two quarters, production has been growing at a rapid pace leading to a slump in prices.

 

Despite the strike at Vale’s Sudbury mine in the month of August, stocks piled up on the LME, indicating that the demand for nickel remained weak. Aluminium has remained a laggard since the start of the year as stocks continued to pile up in the LME warehouses and were pegged at 4.5 million tonnes, which was 2.4 million tonnes at the start of the year.

 

Asset allocation towards commodities has increased throughout the year owing to several reasons. Notable among them are various stimulus packages world over, monetary and fiscal easing, credit spreads indicating good credit availability in global financial markets and a weaker dollar resulting in dollar carry trade, that led to a rally in various risky asset classes, base metals being one of them.

After the massive stimulus package from the Chinese government, the Manufacturing Index and industrial production began moving up. Focus on domestic consumption via spending on infrastructure was the message being sent out by China as its exports have taken a serious hit following the recession in USA and Europe, which continued to be the top destination for exports.

After China, we got confirmation that the recovery in the OECD area has gained ground. The growth of GDP in Japan, Germany and France surprised many.

 

Leading indicators such as the Manufacturing Index and industrial production point toward a recovery in the global economy. Going ahead, we expect the global industrial production to rebound further in the year to come which will drive prices of base metals up.

 

 

WHAT’S CHINA UP TO?

 

Builders of China's infrastructure have benefitted from Beijing’s 4 trillion yuan ($586 billion) stimulus spending package. China has massive expansion plans as far as infrastructure projects are concerned. China’s hunger for natural resources is evident from the fact that Chinese companies have been acquiring debt-ridden mining entities at reasonable prices during the downturn. Industry and construction account for 49.2% of China’s GDP.

 

Around 8% of the total manufacturing output in the world comes from China alone. It ranks third worldwide in industrial output. With China stocking base metals and showing hunger for natural resources, many would wonder where the consumption is going to come from. Following are few of the plans China has envisioned which might require metals and other commodities to boost its infrastructure.

 

China’s 11th Five Year Plan includes extension of the country’s National Trunk Highway System from 41,000 km in 2005 to 65,000 km by 2010.

 

The Chinese Transportation Ministry is expected to spend more than $1 trillion for highway construction. China is focusing on three areas. a) the toll road network in China East, b) the main highway in China Central and c) construction of inter-county roads in rural areas across the country. The government plans to complete a total of 80,000 km toll road nationwide which is likely to connect 319 cities with population of more than 2,00,000 each.

 

The Ministry of Railways is considering of expanding the present network from 78,000 km to 1,20,000 km by 2020. It is also considering of investing in 800 speed trains over a span of three years. China is also focusing on constructing a metro rail network as tier-II cities are seeking approval to start more such projects.

Between 2006 and 2010, $200 billion is expected to be invested in railways alone, four times more than the past five years.

Development of ports is also picking up in China at a rapid pace as it remains their top priority because it has three of the world’s top five business ports.

 

Airport expansion is also one of the areas where the government intends to spend heavily.

 

The world’s largest population requires better water management. China requires waste management infrastructure to enhance efficiency of local municipalities. Due to shortage of water in northern China, the country intends to invest heavily in this area over the next 10 years.

 

China’s power capacity is expected to exceed by 870 GW in 2009 as compared to the US’s capacity of around 980 GW and may reach 1,250 GW by 2015. Power has been one of the major areas of concern for China. With robust economic growth, the demand for energy is likely to outpace supply and government agencies are drafting plans to spend heavily in this area. Wind power generating capacity has surged at a rapid pace.

 

Policy planners are now warning of rigorous overcapacity in the sector as more and more dams are being constructed on China’s rivers distorting the flow of water and thus posing a potential earthquake hazard.

 

China’s installed wind power capacity now is 12.17 million kilowatts, up from 3,50,000 kw in 2000. Largescale solar energy facilities are also being planned. Interestingly, 54% of the demand for copper comes from the power sector, which is most likely to increase in the near future.

 

By 2020, China’s renewable energy should account for 15% of the national primary energy consumption, supplying the equivalent of 600 million tonnes of coal.

 

Infrastructure spending in the oil and gas sector in China has remained robust with a rapid rise in demand in a decade. In 1997, China’s refining capacity was around 4.5 million barrels per day which has shot up to around 7.9 million barrels per day in 2008 and may touch 8.5 million barrels per day by 2011.

 

The demand for various base metals in China is expected to remain robust and any major disruption in supply is likely to spark a sharp upside in prices of base metals. China will require metals and other commodities to fulfill their plans.

We wonder what would happen to the prices of base metals if other developing countries start formulating aggressive plans like China and become as hungry for natural resources as the Chinese?

 

 

IS CHINA'S APPETITE FOR BASE METALS WANING?

 

China has been aggressive since the last Ihree quarters but we have seen a drop in Chinese imports in ihe last two months. Despite the drop in refined copper and several other base metals, prices have been trading firm. On Ihe LMK we recently saw copper, zinc and aluminium hitting fresh highs of 2009. Nickel alone has been a laggard and prices have been trading low.

 

In the first two quarters of 2009, if one compares the surge in imports with 2007 and 2008, the rise has been humungous. But the drop in imports docs not mean prices can crash sharply,

 

A weak dollar has been a major factor for lending support to the prices of base metals. This has triggered good investment demand for copper as well as supply concerns due to strikes and accidents in major copper and zinc mines across the world.

 

Better lhan expected data from OHCT) countries revived the demand outlook for industrial metals. Apart from China, countries like South Korea too have been adding base metals in their strategic reserves.

The drop in imports of these metals is a negative factor bul hopes of recovery and positive economic reports are supporting the prices. Markets are running ahead of fundamentals. Agreed that Chinese imports of base metals arc going down since the last two months, but we can*t conclude that markets may crash as its imports are going down.

 

 

RISING PRODUCTION A WORRY?

 

Like other commodities base metals arc also cyclic in nature and if supply exceeds demand, then markets may witness a correction. In the case of base metals, the output of most of these industrial metals is moving up in China since the second quarter. Reasonable prices are encouraging miners and smelters to fully utilize their capacity and start their idle capacities, which may lead to an oversupply if demand doesn't rise at the same pace.

 

RISING INVENTORIES ON LONDON METAL EXCHANGE A CONCERN

 

Agreed that a robust Chinese growth plan can result in a sharp upside in prices of base metals, but there has been a mismatch in LME's prices and warehouse stock for most of these base metals. At present, there's a deviation as prices are moving up along with rising stocks in most of the base metals, except aluminium and nickel.

 

In case of copper, the inventories have been moving up since June *09 from 2,70,000 tonnes to almost 4,35,000 tonnes presently, whereas prices increased from $4,700 to $7,100 per tonne.

 

In zinc too, prices have moved up from $1,500 in June *09 to 52,200 on the LME but stocks have risen from 3,35,000 tonnes to 4,49,000 tonnes during the same period. Same is the case with other metals. Not just on the LMH, stocks are rising at rapid pace even in Shang¬hai Commodity Exchange,

 

 

 

 

 

 

 

IN A NUTSHELL

 

The drop in copper imports, rising output in China for most base metals and a surge in inventories on the London Metal Exchange and the Shanghai Commodity Exchange indicate that before base metals take the next leap, a correction of 5% - 8% cannot be ruled out as it seems that the markets have discounted a lot of positive news in advance.

The slight reversal in the dollar that occurred recently may cause some long liquidation as markets remainedoverbought in base metals. We do not remain very bearish on the complex as demand from China and other emerging markets are likely to drive up the prices of industrial metals.

 

Despite record inventories, aluminium looks strong for the first quarter of 2010 as rising costs of producing aluminium and index rebalancing can really help prices as it has been a laggard since the start of 2009.

 

The long-term outlook on the complex still remains positive as China’s strong will to become a developed nation and its ambitious plans are likely to drive the demand for industrial metals in the coming years. Other developing nations are yet to show the same kind of will. If they do so, the prices of base metals can take a big leap from the present levelS.