Might be a few years before any appreciable bounce in the copper...

Might be a few years before any appreciable bounce in the copper price, considering current LME stockpiles and economic contraction.

An analysis of likely copper consumption patterns in China over the next two to three years.

Author: Simon Hunt
Posted: Friday , 05 Dec 2008

WEYBRIDGE, UK -


Most countries in the world are in recession. China is no exception; its economy has been spiralling downwards since the Olympic Games. Talking to industry friends in the country is not a happy experience; the message is pretty well uniform. Downsizing, restructuring, workouts, litigation etc. arising out of order books suddenly falling off a cliff, whether domestic or export; contractual defaults, postponed or cancelled orders are all a common theme.

The shocking slump in China's November PMI, with the New Order constituent down 46% year-on-year and a mirror image of the US PMI sub-component, merely confirms what manufacturing friends in the country were telling us. No wonder that government is slashing interest rates, increasing money supply and introducing a series of fiscal measures - with more to come. Panic has set in.

What China's rapidly decelerating economy is telling us is how dependent the economy is to what goes on in the world outside its own country. It was exports which originally gave the country the financial foundation for its rapid growth, probably the largest and fastest rate of industrialisation in history.

And it is exports which are the largest single component of GDP, accounting for some 40% of GDP in the first half of 2008. China's dependence on outside forces for growth does not stop there. There are the important feedback loops of investment, employment and consumption. They could well account for another 20-25% of GDP. The first will fall, the second is declining and the third will be impacted.

The importance of where the economy outside China is heading should, thus, not be underestimated. Our economic profile is based, to some extent, on the impact of global wealth destruction on GDP. John Makin, visiting scholar at the American Enterprise Institute (AEI), estimates that a total of around $40 trillion of global wealth will be destroyed perhaps by late next year, with the USA accounting for about $15 trillion. Using various formulae correlating wealth destruction with global GDP, the eventual global GDP loss could be larger than what was experienced in the 1929-1934 period, spread over 5-10 years, only partially recompensed by today's fiscal and monetary responses to the crisis. A muted and short-lived recovery, associated with a collapsing US$ and rising US interest rates, should occur sometime in the second half of 2009, but one that is likely to be aborted before the end of the following year (that is a story for another day).

The impact of these developments on China's economy and its copper consumption will be dynamic. Quite how successful will be government's efforts to stimulate the economy is difficult, if not impossible to guess, because business and consumer confidence has been shattered. And confidence is a fickle beast at the best of times. At best, real GDP could grow by 7.5% next year, but the risks are all on the downside.

China's copper consumption will be significantly impacted by these global developments, because some 30% of consumption is exported in one form or another, such as semis, wires & cables and copper contained in the export of finished goods. Unlike previous downturns, US and other consumers will be saving rather borrowing. The export market will simply not be there for consumer and capital goods, no matter what incentives China's government will give to exporters. Moreover, foreign competitors will not roll over and allow Chinese companies to take market share. Looking at the composition of China's copper exports - in whatever form - they should fall every year through to 2012 anyway, a loss by then of some 350kt compared with 2007, in our view.

Consumer goods account for around 30% of consumption. Almost half of the production of consumer appliances is exported. The export market is dead, as can be seen from retail sales data in the USA, Europe and Japan. In fact, exports of consumer appliances are unlikely to reach the levels seen last year for the foreseeable future. Net worth will be reverting to the mean, implying that after fifteen odd years of living beyond his/her income, consumers will be saving.

Domestic demand for household appliances etc. is weak also; the urban areas have become mature markets dependent now on replacement demand, which, in turn, is influenced by confidence. Government policy is focusing on stimulating disposable income in rural areas, but this will take some years before this market takes off.

There are also large stocks of nearly all consumer appliances; production rates will now have to be adjusted to allow for the liquidation of these surplus inventories. Copper used in consumer goods will be lower this year and next with a modest recovery in 2010.

Construction accounts for another 25% of consumption. Property is a large chunk of construction and the major part of copper's usage in this sector; and it accounts for one quarter of fixed asset investment. Property, too, is in a slump. Since the housing reforms were first introduced in 1997, the sector has grown by 25% a year. It has been a major driver behind copper consumption. Now it is falling.

Completions are running far in excess of sales both in Tier 1 and Tier 2 cities. Prices are falling and have further yet to decline. Part of the stimulus package is a plan to build low-rent units, redevelop slums and renovate deteriorating rural housing. However, this plan consists only of a small part of the existing real estate market. It is unlikely to start impacting the copper which goes into construction until late next year. Copper used in construction will fall this year and next, starting to recover in 2010.

Infrastructure accounts for some 40% of copper consumption with the bulk being for power cables. China's medium term growth is likely now to be in the 6-8% range rather than in the +10% level. The demographic profile of the country, with fewer net new entrants coming into the labour force, makes a lower growth rate socially possible.

The short-term development of factory closures, leading to workers seeking new jobs, fits the labour intensive infrastructure projects like roads, railways, bridges etc. rather than unwanted electricity generating and distribution capacity.

The economic uncertainties recently being experienced in China together with falling raw material prices encouraged Power Supply Bureaus and the private sector to postpone or even cancel orders. Slower growth has been seen since the start of the fourth quarter. This will be seen also for copper used in the production of power cables. There is another factor to consider. In some provinces aluminium is starting to be used as the conductor for medium voltage cables. The bottom line is that China's refined copper consumption, as defined by material going into furnaces, will be flat to down both this year and next before rising, hopefully, by some 9% in 2010.

In assessing China's copper consumption, as defined above, two factors should be born in mind. In the second half of 2004 and early in 2005, a very large tonnage of cathode was imported by one group as an investment and stored in warehouses outside Shanghai. Most analysts have assumed that this tonnage constituted consumption. Also in 2007, a lot of cathode was imported into China which also never went into furnaces. Thus, most analysts' base consumption numbers are far too high with consequences on China's import requirements and global balances.

Simon Hunt was one of the founders, in 1975, of top metals analysis consultancy Brook Hunt, which still bears his name. He left at end-2005 to start up Simon Hunt Strategic Services which specialises in copper, global economics and China. For further information please contact Simon Hunt at Simon Hunt Strategic Services on 0207 859111 or [email protected]