by Stuart Burns
The latest set of data and various reports confirm that metals demand is strong and growing in China. Even as Beijing escalated efforts to close less energy-efficient and smaller smelting capacity across the metals sector, production has only increased. In fact, Beijing’s efforts to close less efficient, smaller plants may actually be having the effect of increasing overall production, as plant owners close old plants and re-invest in newer, more energy efficient and inevitably larger plants.
Beijing instructed local governments to cut nearly 28 million tons of steel-making capacity and more than 2 million tons of lead, zinc, copper and aluminum, up from orders issued only a few months back in May. How much success they have remains to be seen, but with smelters averaging capacity utilization of something like 80%+ and all metals above the cash cost of production (with the exception of aluminum, which is around break-even at present), there is no incentive to close old capacity without replacing it with new.
China’s economy slowed very slightly in Q2 from Q1; but GDP growth still remained a robust 9.5 percent, supported by continued infrastructure investment, social housing construction, strong retail sales and buoyant exports. Clouds linger on the horizon, but those predicting a sharp contraction in growth have so far been perplexed. Repetitive increases in bank lending requirements, increased interest rates and a gradually strengthening currency, have failed to do more than ease the pace of growth. Fixed asset investment grew at 25.6 percent in the first six months of this year, according to Reuters, while retail sales grew 16.8 percent, showing Chinese consumers are unperturbed by the sovereign debt crisis in Europe or slowing U.S. growth figures. Still, with Europe and the U.S. being China’s two largest export markets, some slowdown in exports must materialize in the second half of this year.
Even if Beijing is successful at closing older plants, it may well not have any impact on production as, according to Reuters data, China has over 2 million tons of excess aluminum capacity and 1 million tons of copper. Copper may slow anyway due to tight scrap supplies, but the surprise has been lead.
Following environmental problems associated with lead smelters, many expected swift sanctions would result in wholesale smelter closings. In fact, although production fell 13.3 percent in May following Beijing’s actions, June’s production figures surged 29.2 percent higher to 446,000 tons per month — some 40 percent of global production. June output was 20.9 percent higher than a year ago and is just 0.4 percent from the record 448,000 tons set in November 2010. So much for an environmental clamp down.
Therefore the overriding picture is one of continued robust growth, despite expectations that China’s economy would rapidly slow in the face of domestic tightening and slowing export markets. The transformation from export-led to domestically driven economy still has a long way to go, but Chinese consumers clearly have sufficient confidence to continue spending. Inflation at 6.4 percent no doubt helps encourage buying now rather than waiting several months for that car or appliance, when the price may be higher. Official inflation expectations stand at 4.8 percent by year-end, but with June’s headline at 6.4 percent, that may be a tall order.
An RBC analyst, in an interview with Reuters, said he expected at least one more interest rate rise this year, probably in Q3, before rates began to fall. Let’s hope he’s right; a gradual easing in the world’s second-largest and most robustly growing economy would be best for us all, while a hard landing could have a profound impact on metal prices and the global supply balance.