Rebel Traders – Analysis Without The Hype

Another sign of the Chinese muddling in commodities has emerged when it was known that Chinese imports of Iron ore exceeds the demand by 50 million tons for this year.  Speculation (and accumulation of commodities) both by Chinese State authorities and Chinese private actors trying to front-run the expected recovery has brought up an excess of iron ore on the market, thus allowing no room for further upward evolution in iron ore prices.

China’s iron ore imports have exceeded actual demand by about 50 million tonnes so far this year and the oversupply leaves no room for further price rises, a senior official of the China Iron and Steel Association (CISA) said on Monday.

“We believe the Chinese iron ore price is largely influenced by speculation on the market,” CISA’s Vice Chairman Luo Bingsheng told reporters at the sideline of an industry conference in Beijing.

China imported 405 million tonnes of iron ore in the first eight months of this year, up 32 percent from a year earlier, to feed its rapidly growing steel output.

The country’s annual capacity is expected to top 700 million tonnes by the end of this year, with production of around 600 million tonnes of crude steel in 2009, hefty growth of 20 percent from the all-time high of 500 million tonnes in 2008.

The benchmark price of Indian origin ore with 63/63.5 percent iron in China has stabilised at about $90 per tonne, below the year’s peak of $115 hit in early August, but still above the contract price of about $75 cost and freight.

Additionally, Luo called for a revision of ongoing annual price talks, which he said would benefit both steel mills and miners, but gave no details.

“The traditional negotiation system no longer matches the current market situation. We think it is necessary to make some changes and adjustments, but they should be decided by both the buy side and the sell side,” Luo told reporters.

China broke the rule this year by agreeing to a 35 percent cut from 2008/09 prices with Australian upstart miner Fortescue Metals Group, despite the top miners’ “take or leave it” approach to the 33 percent price cut first reached by Rio Tinto and Japanese steel mills.

The annual conference involving CISA and the steel industry, led by top producer Baosteel, is traditionally seen as a warmup for annual term talks.

CISA Secretary General Shan Shanghua told Reuters earlier that his group would seek to change contract terms to the calendar year instead of the April-to-March fiscal year.

Shan also said talks over 2009/10 prices were continuing with Brazil’s Vale and Australia’s BHP Billiton six months into the contract year, but added that China was not in talks with Rio Tinto.

As regards overall steel production, whereas steel production fell all over the world Y/Y, in China the production beat its 2008 output (see below graph, courtesy of Steel Grips)

On the whole, the seel production alone would indicate a recovery if there wasn’t a serious issue of overcapacity in China. This overcapacity is forcing some Chinese steel mills to cut prices up to 58 $ per ton.

Despite this, the Chinese stimulus may provide for some nice results in Asian steelmakers.

Asia’s big steelmakers likely saw their earnings exceed expectations in the latest quarter on unexpected strength in China’s economy, though the spectre of oversupply looms as a key threat in the year ahead.

The sector is pulling out of the worst slump in decades thanks to stimulus measures by governments around the world, including China’s near $600 billion package focused on infrastructure that prompted a spurt in exports by JFE (5411.T), Nippon Steel (5401.T) and POSCO (005490.KS) to capture demand.

However, the issue that lies ahead, as previously mentioned is the Chinese oversupply… And there is not going to be a market sufficiently vigorous to catch up all that supply.

But the threat of oversupply from China clouds the outlook at a time when manufacturers are still cautious about spending for new plants, and housing and building starts remain in the doldrums.

Steel output at China has been growing at a rapid clip. The country’s annual capacity is expected to top 700 million tonnes by the end of this year, with production of around 600 million tonnes of crude steel in 2009, a hefty growth of 20 percent from the all-time high of 500 million tonnes in 2008.

Lakshmi Mittal, chairman of the world’s largest steelmaker, Arcelormittal, told the Financial
Times in a recent interview that prospects for a world steel industry rebound could be blown off course by a strong rise in exports from China.

Chinese stats (as collected by a Private actor, the bank HSBC, for those who don’t believe any government stats, whether US or Chinese), continue keeping up a strong front, despite the plateauing that could be observed in the US, where new orders met with some pullback in September.

The Chinese purchasing managers index kept above 50 %, thus indicating a continued expansion in the month of September, even if the number fell by 0.1 %. The greatest challenge to be observed so far for China has been its excessive reliance on exports as a motor for its economy. However, despite these issues, it would appear that the majority of the rise in new orders came from internal demand. And this is a factor worth noticing, as the big challenge for the Chinese is managing to develop an internal market. So far, it would appear that this has been done mainly thanks to stimulus and directive instructions to buy or spend (very efficient in a dictatorship).

As the HSBC analysts seem to indicate, the operation by the Chinese government may have pushed up consumption via the gigantic infrastructure spending (which also pulled up employment, in a textbook illustration of traditional keynesianism).

China’s purchasing managers’ index fell by 0.1 percentage points to 55 points in September, the sixth consecutive month the indicator has been above 50, HSBC said in an email statement on Sept. 30.The 50 point mark is the dividing line between expansion and contraction in purchasing, the statement said. Despite the slight decline, the index still indicates strong growth in factory output, orders and employment.

Factory output has expanded for six months in a row due to an improving economy, while overseas orders have risen for the past four months as demand has rebounded, it said.

The majority of the rise in new orders, however, came from domestic demand, it said.

The growth in sales has helped push employment in the manufacturing sector to a two-year high, the statement said.

Overall product prices have risen slowly but steadily over the past three months, but larger hikes in the prices of corn, iron ore, oil and steel have pushed up overall costs, it said.

“The figures indicate a continued rebound of domestic and overseas demand, and the rise in employment levels in manufacturing shows the massive infrastructure investment has pulled up consumption,” HSBC’s chief China economist Qu Hongbin said.

HSBC began publishing monthly PMI figures on Sept. 1. It collects data from 400 companies.

The other aspect of this massive investment spending has been the overcapacity being developed in China. The Chinese government decided to tackle that too, in order to create what would appear as maybe an attempt to foster penuria in some areas (silicon and wind power among others). While curbing the overcapacity in steel or cement makes sense given the quantities being produced, the curbing of wind power (a “clean” energy source) leaves one wondering if this is not an attempt to keep the coal production buoyant (the greatest part of China’s power comes from extremely polluting coal power generators). A very near-sighted operation if ever there was one, but which translates the worries of Beijing on its social front.

The Cabinet has laid out detailed plans to curb overcapacity in industries such as steel, aluminum, cement and wind power, warning that the country’s economic recovery could otherwise be hampered.

In a reiteration of existing policy targets, the State Council said meeting the government’s long-standing goal of reducing overcapacity was urgent because the result of inaction would be factory closures, job losses and rising bad bank loans.

In a notice posted on the Internet it said, “What especially requires our attention is that it is not only traditional industries such as steel and cement that suffer from productive overcapacity and are still blindly expanding.”

While highlighting overcapacity in sectors such as steel and cement — both energy-guzzling and polluting — it also aimed at new industries such as wind power equipment and silicon.

The Cabinet said it would no longer approve or support any new steel projects or any expansion in existing projects.

Shenzhen Daily also reports that the wind power industry was mentioned which is, perhaps, surprising. It said that in 2010 Chinese companies would produce equipment equivalent to 20 million kilowatts of capacity, but that the country would install only 10 million kilowatts of actual capacity.

To tackle this oversupply, the Cabinet said it would in principle refuse approval the construction of complete wind-power equipment factories. It also banned investors in the sector from using locally produced equipment, aiming to prevent local governments from building their own equipment plants.

Two of China’s main issues, i.e. unemployment and overcapacity had some measure of “good news” this week. In reports from China’s coastal regions (the most dynamic economically),  we learnt that while exports have started to pick up, employers are now having issues with finding laborers.  As I mentioned earlier, several millions of Chinese laborers returned to the country earlier because of hardship in the cities. With the demand picking over, these laborers are now in short supply in those economically active areas of China.

Although China’s employment situation is still grave, a shortfall in labor resources has cropped up in some coastal regions as both domestic and world economy are making positive changes.

“Finding workers is my priority now as export orders have started to pick up since June,” said Xiao Senlin, a senior manager of the Ha Yi Dai Toy Factory, which is based in the booming city of Dongguan in China’s manufacturing base Guangdong province.

(…)

Xiao’s company was not the only example of the impact of labor shortages. A lack of workers is spreading in export-oriented enterprises in two of the country’s major manufacturing bases: the Pearl River Delta and Yangtze River Delta regions, as orders pile up.

Those suffering labor shortages are most small and medium-sized enterprises, which are China’s major employers of migrant workers.

Wenzhou, a coastal city in eastern Zhejiang province, estimated a rural labor resource shortage of 150,000, most in some traditional labor-intensive sectors such as spectacles, garments, shoes and electronic goods manufacturing.

Like Xiao, Chen Aimin, a human resources department manager at Kuoshuai Garment Company in Wenzhou, was in a dilemma — he was happy to see order increase but worried about a lack of workers.

“We did not expect that our orders for the second half this year would be 40 percent more than last year,” Chen said. “As a result, we did not employ enough workers and now it becomes difficult to recruit new workers.”

According to Wenzhou customs statistics, the city’s garment exports rose 10 percent in July from a year earlier while shoe exports gained 2.7 percent year-on-year. However, compared with June, garment exports increased 12 percent last month and shoe exports surged 35 percent. The two sectors’ exports accounted for 45 percent of the city’s total export volume.

Although exports, a bedrock that fueled China’s fast growth in the past few years, fell on a year-on-year basis last month, there were signs of improvement. July exports fell 23 percent from a year earlier, but increased 10.4 percent from June.

But some analysts warn that this increase could only be due to “seasonality” and a preparation for the Christmas season.

However, some analysts warned the current labor scarcity after the export order increase was mainly a result of seasonal factors instead of solid growth in external demand.

Most of the order increase was from daily necessities as foreign retailers started buying for the coming Christmas shopping season, said Zeng Shuiliang, an expert with the Yangtze Delta Region Institute of Tsinghua University.

On the longer-term, this could redistribute the economy of the region and favor the development of regions until left far behind in their economic development:

Besides the economic uncertainties that may hinder employment, some far-sighted experts are pointing to labor resource conflicts between the country’s coastal region and the relatively under-developed western region.

In southwestern Chongqing, one of the country’s major sources of migrant workers, going to the east coast to be a migrant worker is no longer an attractive option.

Compared with Chongqing, the earning in the coastal regions was not as attractive as it used to be, said Sun Huiju, manager of a local labor service export agency. Meanwhile, many of these home-returning migrant workers got re-employed locally and did not want to leave their hometown again, Sun said.

Labor resource conflict between the country’s east and west would be natural in the long term as the western regions’ economic development picked up and people’s earnings increased, said Wang Ying, a workforce official in Chongqing.

The backflow of migrant workers to the western regions would help industrial structure adjustment, Wang said.

However, even as the recovery appears to be still weak on the global plane and as inventory reconstitution can only go so far, the Chinese authorities have started addressing the issues of overcapacity we have been talking about on this blog for some times now.

China’s cabinet said it will make efforts to curb overcapacity and investment in the steel and cement industries, among others that may be overheating due to China’s stimulus plan, AP reported, citing state media. Industry regulators will “enhance management” of other industries including flat glass, wind power, polysilicon production and chemicals, the Xinhua New Agency reported, following a cabinet meeting led by Premier Wen Jiabao. The cabinet also said it would take measures to strictly enforce both environmental standards and market access. China’s US$586 billion economic stimulus package has led steel and cement manufacturers to step up production for public works projects, leading some economists and business leaders to warn of excess capacity across industries.

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