Don't Bet Against Chinese Demand Growth Just Yet 13 comments
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Last week in ScotiaBank's China Update, a subtle change was noted in wording to the Chinese economic policy statement:
"At the beginning of the year, the Wen Jiabao administration stated the two policy priorities this year were to prevent full-blown inflation and economic overheating. Now, the wording has quietly changed to prevent full-blown inflation and a "big fluctuation of economic growth."
The question is - does the Chinese Government know something, and would it tell us if it did?
Look, it seems quite likely that the Chinese growth rate has slowed. We know exports must be hurting. As the Economist magazine pointed out earlier this year, exports account for enough of China's growth to slow it down by maybe two percent. Well two percent isn't going to cause the world to end, and it isn't going to cause a commodity meltdown either. The bigger concern has to be that a slowdown in exports creates a tipping point that sends shockwaves through the rest of the economy.
Are We at a Tipping Point?
The problem with evaluating China is one of credibility. The statistics coming out of the economic wing of the government are suspect. There is a good chance that the books are cooked. Use the official statistics to evaluate growth prospects is mostly an exercise in discerning what they want you to believe.
I think that the best way to evaluate China's economy is by looking at the commodities and the shippers, and gauging from their statements the health of the developing world which relies on their product. It's an inexact science, yet business folks tend to be more honest on the whole then politicians (even those who don't ever have to get elected!), so I'd rather rely on them than numbers that could be pulled from thin air. And while Congress may believe otherwise, I do sincerely doubt that speculators are the main influence on commodity prices. I doubt even more that they are any influence on the inventory of those commodities. Raw material prices are mostly settled on supply and demand, and demand these days is mostly settled on China. The prices, inventory levels, and the comments by suppliers of raw materials, seem to me a much better measure of China's economic health then do employment estimates and durable goods orders.
So What Do the Numbers Say?
It's a mixed bag, and really, there's no clear trend as of yet. For instance, the Baltic Dry Freight index, a measure of ocean going freight traffic, is down to almost 8300. This is way down from over 11,000 as recently as May, but it is also still up year over year. The Baltic Index is also notoriously fickle. It has a tendency to fluctuate wildly with seasonal swings in the need for ships. So far, the long-term trend remains intact.
Omar Notka, from Dahlman Rose describes the freight situation as such:
"Steel prices have come under pressure recently in China, falling to one-month lows. The monsoon season in Southeast Asia has caused construction project delays, creating a slowdown in steel ordering reflected in pricing, particularly for billets and rebar. These seasonal considerations have exacerbated a somewhat uncertain outlook for the dry bulk market, reflected in the marked volatility and wild swings within the stocks. Slower growth in power generation in China has also created concern. However, the contango within the FFA curve and unchanged time charter rates from the peak of the market suggest a potential reversal of the current sluggishness later in the year."
And what about steel? Steel and iron ore prices have been strong, but there some signs that demand has slowed in the stainless sector. The Jinchuan Group said earlier this week that China's stainless steel market has seen a slump this year "on oversupply and a slowdown in downstream consumption."
Others though are saying the opposite, and chalking up the slowing demand to seasonal factors, a temporary halt of some industries due to the Olympics, and the falling price of nickel (stainless buyers buy less when nickel is falling because falling nickel means falling steel production costs and eventually, falling steel prices). Outokumpu, the world's 4th largest stainless steel, had this to say about the stainless sector:
"Underlying demand for stainless steel from most end-use segments is stable. As a result of the increasing uncertainty related to the global economic turmoil, some weakness is evident in consumer-driven segments such as white goods and construction. Demand from investment-driven segments continue generally healthy but some projects have been postponed because of the economic uncertainties."
Stainless should be a better measure of residential demand, and with residential construction falling off the cliff, one shouldn't be too surprised that the outlook for stainless demand is murky. In particular, Acinerox, which is the world's largest stainless producer, said that in particular to their sales, the property market slowdown in Spain was affecting demand.
The demand for more industrial steels still appears strong. Indeed, the iron contracts settled first by Rio Tinto (RTP) and followed by BHP Billiton (BHP) did not suggest any softening in demand. Most recently (yesterday in fact), the Financial Times had this to say:
"While there is a slowdown and softness in some markets, in particular in southern Europe and the US, I don't see any major weakness in overall levels of demand," said Lakshmi Mittal, CEO of ArcelorMitall (MTL). While demand in emerging economies such as China, India, South America and the Middle East remained strong, global demand was likely to expand by 3-5 per cent a year in the next five years, against an average growth rate of 7 per cent in the past seven years"…"If you accept my growth estimates, that means the world will have to find another 50m-75m tonnes of steel capacity every year for some time."
As for the base metals, it has to be said that they have been surprisingly strong. If anyone had told me that copper would trade at $3.70 with housing starts in the United States looking to come in below the million mark, I wouldn't have believed it. Copper inventories remain at reasonably low levels.
It's true that nickel and zinc have been weak, but these are both supply-side stories. For nickel, the ability of producers of nickel in pig iron to improve the efficiency of their production has been inspiring. ScotiaBank recently pointed out the nickel-in-pig producers have brought down their costs to between the $8-$13 mark, and that with iron prices so high, they may soon get by-product credits for their pig iron, thus bringing down costs further.
The surprise with zinc, if any is how the price can stay so low while the anticipated surplus continues to disappoint. The zinc gurus, Brook Hunt, CRE and the like, had been predicting as much as a 600,000t surplus this year. It now looks like that number will be lucky to break 200,000t. Teck Cominco (TCK) said on their conference call last week that demand for zinc was as strong as it ever has been in the second quarter.
What Can You Say?
The conclusion to be drawn from all this is that one cannot be drawn. The evidence certainly isn't conclusive. And in the light of the inconclusive evidence, what do you do?
Well, I think you have to fall back on the evidence that is indisputable. And that is the historic trend. The historical trend shows that China has been growing at, on average, 9% for about the last 20 years. That's a long time. It's the kind of trend that you need a lot more then a few Central Bank comments to trump.
The theory that I've brought forth before in these articles deserves repeating. City growth is an internal process. It is a process that is bred by the replacement of goods that were previously imported with goods that are manufactured (and eventually designed) in the city itself. This process of import replacement is taking place across the developing world. The previously imported goods that are being replaced by locally made goods are everything from door handles and window frames to refrigerators and automobiles. The number of people partaking in the process is more then the number of people that have partaken in it in the history of humankind up until now. Equally large are the number of goods already used by OECD countries that are just waiting to be replaced locally by manufacturers in these burgeoning, import replacing cities, as their customer base grows their income to levels where they can afford the consumption.
You have to understand that this is a massive force with incredible momentum. It is not something that can be easily stalled. I simply do not believe that it would be prudent to discount it, in the light of murky evidence to the contrary, and some comments from a trigger happy Central Bank.
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This article has 13 comments:
Excellent article. As you pointed out so well it is absurd to believe that Central Bankers have the ability to slow or stop a multi-year growth pattern in emerging markets. And the arrogance of US financial experts on the issue of "decoupling" is incredible. They completely ignore the fact that in 2008 for the first time ever, China will export more goods to Europe,Asia, and the Middle East than the USA. In the grand scheme of things the subprime mess has little if any impact on global growth patterns. China slowing from 10% to 9% is not going to out any appreciable dent in commodity demand. This commodity bull has several more years to run. In the meantime avoid Financials stocks like the plague. They are toxic right now.
"As the Economist magazine pointed out earlier this year"
I would like to read it.
KenK - I sent seekingalpha a note about the incorrect symbol. They put in the symbols, i didn't have anything to do with that.
The survey out today of purchasing managers supports more than a reduction of manufacturing due to smog conditions relative to the Olympics. This is a national issue.
You have not yet seen the effect in China of the sharp reduction of sales to Europe and USA, which are coming. Recession in both will cause lower exports from the US to Europe which has been supporting recent growth in the US. Sales outside the US have been the majority of the earning growth of US international companies.
It seems to me that the Europe recession which is only now beginning to take hold will greatly slow US export sales and will likewise impact China. As US and Europe slow, all exports from China slow, with growing factory closings and rising unemployment while at the same time inflation grows from 7% to 12% in China. Could get real interesting to watch the China government under these conditions!
So bottom line, China stock markets continue to fall back to the 2004-05 level. What do you think about that?
I'm a Jane Jacobs fan too, and I think your application of her logic is correct, at least if you view things on a sufficiently long time scale.
However, IMHO you sound a bit too much as if you believe that there is no business cycle in China. There surely is. I expect that, like usual, it will feature financial busts -- more than usually spectacular, given the scale of everything in China -- followed by huge and ham-handed government interventions, which imply slow and long drawn out recoveries. Michael Pettis offers some reasons to believe that the Chinese financial system is in more than the usual amount of trouble right now.
Also, just as happened repeatedly in the US in the 1800's, foreign investors will frequently get thoroughly screwed. When things get messy, the government has to step in, and that means allocating pain and bail-out money. That's inherently political, and you don't want to be a fully invested foreigner just then.
Investing is never easy. Everything you say about China could have been said about the US in September 1929. But one would have waited a long time to break even if one bought just then -- forever, in the case of many individual issues.
Jim G
Everyone is looking for Bric growth to sustain the West. If that growth slows markedly, what happens to the US/Euro economies?
Everyone has wanted slower growth from the Bric nations, be careful of what you wish for.
www.economist.com/fina...