Metals Weekly: Chinese Overstocking and the Supply Response

Slowing imports, rising production and overcapacity fears characterise Chinese metal markets currently. After record imports of metals, iron ore and crude oil in first half of this year, Chinese imports are slowing month-on-month. The drop is quite remarkable in some cases (e.g. Copper). On the other hand, a sharp rise in prices is helping re-start idled capacities the world over, noticeably in steel, aluminium, copper smelting and zinc. Rising exchange stocks of base metals and port stocks of iron ore vindicate a well supplied Asian market. However, metal prices have broadly ignored this so far. We fear that markets and analysts are under-estimating changing the supply-demand equation.

Chinese surplus, overcapacity

With a 4 trillion yuan stimulus package, $1.1 trillion yuan commercial lending in H1 and strategic buying, China set the commodity demand on fire in the first half of 2009. Chinese imports made records, month after month. Against a total import of 1.46 million tons of refined Copper in 2008, the Chinese imported 2.4 million tons during Jan-July09. Similarly, the import of Iron Ore in Jan-Jul09 rose 45% yoy. With private and strategic restocking topped out, the imports have started trending lower. Copper imports fell by 23% m-o-m in Jul09 and 20% m-o-m in Aug09; IronOre imports fell by 14% m-o-m in Aug09. Given the trend of falling premiums in September and plentiful port stocks, it appears that imports could trend even lower in coming months. A similar trend is visible in other imported commodities as well.

Chinese production of Copper, Zinc and Lead is taking place at a record pace. China produced 364,900 mt of Copper in August, up 8.7% yoy and a monthly record level. Rising demand for copper concentrate by smelters and lag in opening up of mines is continuously putting pressure on spot TCRC which was quoted at $20/2 last week, down from $30/3. Chinese Lead production rose 26% yoy in Aug09 to a monthly record, registering a rise of 6% over Jul09 production. Antaike estimates that despite pollution-struck close-downs, China will have a surplus of 270kt of Lead in 2009. Chinese Zinc production is expected to rise 7.7% this year as new facilities come on-stream. Chalco expects a surplus of 350kt of Aluminium in China in 2009 with restart of 1.28 million Tons of idled aluminium smelting capacity and 3.48 million tons of idled alumina capacity. Chalco is expecting to operate its alumina refineries at 90% of capacity by end 2009. Analysts expect about 700kt of aluminium, 200kt of Copper and 20kt of Nickel as held privately in China which could come out as prices retreat.

Chinese capacity expansions are queued up quite well. Interfax estimates a rise in annual production capacity of alumina, aluminium, copper, lead and zinc by 3 million tons, 2 million tons, 50kt, 200kt and 300kt respectively in 2009. After having increased its zinc production capacity by 100kt earlier this year, Zhuzhou, China’s largest zinc producer, is looking to increase its lead production capacity by 100kt in order to balance the capacities of the two metals. Baiyin, China’s third largest zinc smelter, plans to more than double its total metal capacity (copper, zinc and lead) to 650kt in 3 years. Besides, it plans to build 150-200kt copper smelter by 2011. Chinese steel production could rise 6% to 530 million tons in 2009. With little room for the domestic demand to absorb the excess, metal could flow out to Europe, hurting domestic industry there. Government proposes to take strict measures to contain overcapacity in few sectors. We believe that unprecedented stimulus has led to overcapacity in several sectors in China. This could result in either excess production spilling out of China or a painful consolidation or a mix of the two.

Production restarts

Besides China, rising commodity prices have helped production restarts globally. The trend is starting with big producers who had minimal or no financial obligations tied-up with the idled capacities.

Nyrstar, world’s biggest zinc producer, is starting its Balen smelter (275kt) in Sep after 9 months of suspension; the plant will ramp-up to 70% capacity in Q4. A few weeks ago Nyrstar had announced to end production cuts in its Clarksville (125kt; 40% cut) and Budel plants (240kt; 28% cut). Besides, Volcan restarted its Cerro de Pasco Zinc mine (130kt in 2008) and announced an increase in zinc concentrate output from 690kt to 800kt in next 3 years. Last month, Teck Resources (TCK)said that it will resume full production at its Trail, British Columbia zinc smelter due to recovering demand for the metal. Rio Tinto Alcan (RTP) is also queuing up restart of its alumina capacities. The 15kt Mwana Nickel mine will start production shortly after 6 months of suspension. We are seeing similar trend in Iron Ore and Steel.

We feel that the under-current of supply response is too strong and is not being fully considered by analysts in their assessment of metal balance. Typical cyclicality of the lagging rise in supplies when incremental demand is easing is set to show up in the coming weeks/months. Government’s direct intervention in support of industry may have helped avoiding a short-term pain, but has made the industry altogether skip a healthy consolidation in a downturn. Overcapacities in certain metals like Steel and Aluminium could take long to level out as idled capacities keep restarting on price rises. In the medium term (3-6 months), we expect market to take notice of rising supplies. However, in the long term, those metals which have raw material supply constraint (e.g. Copper, Lead) will win. BHP's statement in this regard is quite interesting.

The last week

Further weakness in dollar enthused base metals, but failed to pull those to new 2009 highs. In other words, in non-dollar terms base metals underperformed. The week ended with a low note across the complex despite strong equities. Clearly, metals are trying to nudge towards fundamentals and are broadly ignoring trend in equity and dollar.

Copper stocks continued to pile-up in Shanghai and LME with 16,227 mt added this week altogether. 3 days of rise in prices were more than given back in last 2 days of the week. We continue to hear softening premiums in Asia with China offering Copper cathodes at $50 FOB.

Nickel continued to be under pressure despite bullish report from Antaike, government backed Chinese research group. The report expects Chinese Nickel consumption to grow 25% yoy in 2009 in line with rising stainless steel production. The report adds that the Chinese market is well supplied currently with an estimated 130kt in warehouses.

While the Chinese appetite for commodities is easing for the time being, we do not expect OECD demand to fill the gap. The recent rise in Aluminium shipments to the western world can be explained by car incentive programs; however, continuity of restocking will be closely watched. The restart of some idled steel capacities in Europe has helped zinc premiums nudge up in the region; however, we expect restart of idled zinc capacities to offset the incremental demand quite easily. Demand for copper and nickel in US and Europe remains subdued.

Market mood

In our last report we were bearish on Copper. Rising stocks, fading flows of new investment money and falling premiums were cited as reasons for our dislike. We find that CFTC speculative short positions are close to fully covered now and that technicals are turning bearish. Copper has ignored dollar weakness of last two weeks and has closed with a loss on weekly basis. Failing to cross the above strong resistance at 6500 after several attempts in last 6 weeks suggests a possible push down to 5850 (50% Fibonacci level) and then possibly to 5600. We expect this to happen in next 2-4 weeks.

Disclosure: None

Comments

[rob134:]

Musing in terms of a Socialist Centrally Run Economy, which has as it's mantra Use Capitalism to Defeat The West; and, which can control, without fear of any constitutional excesses, their entire economy:

Use cheap labor and cheap raw materials to keep people employed and stock pile metals for when the prices sky rocket in 5-8 years, as the world economy returns to expansion. I don't believe the world will be able to absorb the entire over production China is involved in, but China can also use the excess to put others out of business.

In 5-8 years China will have taken another huge bite out of it's competitor, the entire world. The Chinese Central Party thinks in terms of years, not the next quarter.

Sep 21 09:21 AM

[Tuaj:]

Sandeep, where do you see China's coal demand heading?

Oct 04 04:27 PM