Simon H unt Strategic Services

Transcription

1 Simon H unt Strategic Services ECONOMIC & COPPER ADVISORY SERVICES CHINA VISIT REPORT: NOVEMBER/DECEMBER SUMMARY This report is in the form of a summary with the full reports for both the economy and copper being written up on our return to our office in the UK next week Economic Background Leading and other indicators are pointing to recovery in the economy. Recovery is not yet being felt in the activity of many industrial and manufacturing sectors. In fact, in many basic sectors the bottom in the cycle won t be seen until the 1 st qtr of next year. Most of the recovery now being experienced is in the SOE sector rather than the private. One development that many analysts focus on for their optimism is destocking. This is a false dawn. Every industrial company has been working hard to get stocks off their balance sheets. Those producing finished goods such as aircons and cars, have pushed their surplus stocks into the distribution channels, by offering companies in this sector extended cheap credit. The problem is that the NBS does not capture inventory within these channels. In short, stocks have shifted from the reporting sector to the unreported. Analysts who use production, sales and inventories as their building blocks for copper consumption are on a weak base, because many local governments have been inflating production and sales with most inventories now being held within the distribution channels, which as we note, are not captured by official statistics. Thus, what companies within these sectors are reporting to us is different from the published data and what most in the analytical community are now stating. We had direct evidence that our observation is correct: aircon stocks remain massive and only a shade below the extraordinary high levels of a year ago. Stocks remain high too in semi- finished goods from wire rod to power cables. For the former we calculate that inventories will be around 300kt and SCBH/vh Page 1 Simon Hunt Strategic Services SHSS.com

2 for the latter around US$2bn plus at the end of this year. A high level of stocks will delay the recovery in heavy industry and manufacturing. Another point made by the optimists is that by looking at the 12 th 5-Year Plan and observing what is left to complete those objectives future growth can be calculated for many sectors.however, it is very likely that the new leadership will revisit that plan when they unveil their economic objectives at the 3 rd Plenary session in October The main thrust of these objectives will be to improve the efficiency of the economy to partly counter the negative economic influences of a falling labour force. This means improving the functioning of the bureaucracy, breaking up the monopolistic functioning of some large SOEs, attacking corruption and restructuring heavy industry and manufacturing. Out of 94 sub-sectors 64 have a surplus capacity of at least 50%. This leads to over-production, falling margins and wasteful capital. The new leadership is prepared to bear the pain to see through this change. It won t be easy because of the entrenched and politically connected institutions and individuals in the state sector. Improving the efficiency of the economy implies too reducing the total cost structure of doing business, not the CPI or PPI data, but that contained in the GDP deflator which effectively covers all the price changes in an economy. There are serious concerns that these costs have been rising rapidly and could soon approach those of advanced economies. Large-scale restructuring will be painful. The objective is to create units of a size and competiveness that can compete in international markets. The weak will be allowed to fail which will create future problems for the banks. Corruption is a massive problem. One of its centres is local government land sales. Beijing will want a greater control which will then pit themselves against local governments. As a quid pro quo central government may takeover the financing of various social issues, education, healthcare etc. Whilst this leadership may not focus deeply on political reform it will certainly do so in the economic and financial spheres. There will be significant focus on what we call the soft side of growth, education, healthcare, pensions, the environment and so on. We can expect significant changes in these fields. Political reform will be left to the next generation of leaders. Urbanisation is being talked about as the continued cornerstone of future growth. Investment in infrastructure, real estate etc. will focus on the county and township levels. It is here where there are bound to be large-scale investment opportunities. This means roads, highways, railroads etc., to connect these areas with the rest of the country, real estate and the development of small businesses. SCBH/vh Page 2 Simon Hunt Strategic Services SHSS.com

3 The issue is not whether infrastructure and FAI will grow but at what pace relative to that of the last ten years plus. The number of families that were urbanised during the last ten years was 50.5 million. An analysis of the country s demographics suggests that the number to be urbanised during the next ten years will be million. FAI will remain important but at a slower pace than has been experienced over the past 30-odd years. A slowdown in FAI is part of transiting the economy into a consumer and services led country. Slower growth is welcomed by this leadership so long as employment remains robust, which it is. Employment is being driven by the services sector. Travelling around China it is easy to notice the increasing number of people employed on the trains, in the airports, in shops and in hotels which are mushrooming in numbers. Small businesses have been and continue to start up such as hairdressers, restaurants, repair garages etc so boosting the growth of the services sector. The NBS admits that they are not capturing all of the growth of this sector. This development is happening not only in the large cities but across the country. GDP is likely to be a reported 7.7% this year though based on our analysis of taking nominal GDP and discounting it by the GDP deflator real growth will probably be around 4-5%. We don t change our forecasts which are summarised below. Table 1: China GDP Trends China GDP Trends Average % Changes Nominal GDP 16.5% 14.9% 9.0% 5.1% 4.5% GDP Deflator 10.7% 9.6% 4.7% 2.0% 2.0% Real GDP 7.8% 5.2% 4.4% 2.9% 2.5% Source: SHSS Simon Hunt Strategic Services 1.2 Copper We were in Shanghai for the inaugural CESCO/Minmetals copper week attending some of the conferences that took place during the week. One clear message is that the Shanghai week will take over in importance to the LME week. The industry was here not just to listen at conferences (MB, Asia Wire & Cable, Antaike copper etc) and to attend the dinner (over 1200 people) but to negotiate contracts. SCBH/vh Page 3 Simon Hunt Strategic Services SHSS.com

4 There was much chatter too when Beijing will sanction the opening of LME warehouses in China with some suggesting within one year, a view which we think is about right. Ultimately, there will have to be a merger between the LME and SHFE though timing will be further off and dependent on when the RMB becomes convertible. Within China s copper industry, whether producers or fabricators, there is a growing anger at the way that the copper price is being manipulated in London. This view is not just being expressed privately but in public too. Many Chinese speakers at the various conferences made reference to this fact. Perhaps the most outspoken was the deputy general manager of Jiangxi Copper. Here is what he wrote. China s lack of final say in the pricing of copper resources is mainly manifested in the following aspects: 1. Until now, overseas rivals still control monopoly advantages in capital/resource/info/drafting game rules/settlement warehouse clusters and manipulates the market through monopoly/collusion/swindles. 2. As a major buyer on the international market, China does not enjoy certain influence it deserves in the global pricing mechanism for copper resources, and has to passively receive the risk of price fluctuations on the international market. 3. The price fluctuation risk suffered by Chinese enterprises is not only reflected in spot trade, it is also displayed in futures transactions. There are frequent cases of heavy losses sustained by Chinese enterprises through market cornering by overseas institutions with advantages in capital and access to information. In short, China knows the game being played in London: that the LME has grown into more of a warehousing game than a valid pricing mechanism orchestrated by banks and merchants. With the LME soon to be owned by the HKSE (effectively owned by China) the game setters will change. It will be the turn of China to be the game leader. This changing development should be viewed in the context of the new leadership s concerns about the total costs of doing business in China, one that they know must be addressed quickly. An important ingredient to the cost structure of manufacturing is input costs with imported raw materials being a high constituent of those costs. Reducing the cost of imported raw materials that are essential to the country s manufacturing sector will probably be given a high priority. For copper that can be easily be done given the huge cathode stocks being held outside the reporting system within the country. SCBH/vh Page 4 Simon Hunt Strategic Services SHSS.com

5 Amongst the fabricators and end users we spoke to and all are large players with significant market share in their own sectors there are few signs of recovery. In fact, for most the bottom won t be seen until 1 st qtr Even then the very large stocks of finished and semi-finished goods will mean that recovery in real copper consumption will remain week in Yinxin is the centre for HV power cables with ten VCV towers. Most have shut down owing around RMB 100M to traders. On average HV is operating at around 30% of capacity and for the whole power cable sector around 40%. Copper used in power cables remains weak. The State Grid issued a very weak tender, weak in the sense of kilometres being tendered. Aluminium and aluminium alloys are still gaining market share with the future based increasingly on al-alloys. We don t change our forecasts of copper used in power cables: down 12% this year; up 5% in 2013 followed by slow growth. We visited the most advanced High Temperature Superconductor Company (HTS) in China. Within 3-5 years these cables will start being introduced into the State Grid. Electricity transmission losses average 8-9% in China. Given that their annual production is more than 4200Bn KwH that is a huge loss. HTS loss is virtually zero. Compared with conventional power cables with the same outside diameter, HTS can carry 3-5 times more current. The first commercial use of HTS may be in the motors of wind turbines, a market which is scheduled to grow rapidly. We will be monitoring closely this technology as it risks destroying a large segment of the power cable and magnet wire markets over the coming years. Magnet wires remain weak and copper used will decline by at least 7% as stated in our last visit report. From our discussions last week the fall for the full year is likely to be closer to 15-20% partly because of an increasing amount of aluminium being used. Al technology has improved sharply and is now able to draw down to 0.03mm. Given the large inventories of appliances being held in the distribution channels there will be little if any (depending on the appliance) growth in For the aircon sector, suppliers tell us that aircon production next year should be flat. Any growth will be met by inventories which are close to all-time peaks. For ACR tube, it is not just a global weakness in aircons which is worrying but outside China a development towards using al, dominantly in the USA. Where copper retains its role, tube diameter is being reduced from 7mm to 5mm in China. About 35% of production is now using 5mm tube, up from 25% in This means a loss of 40% of copper per metre of tube, a trend which will accelerate. The major Japanese aircon makers are also generally specifying 5mm tube for internal units and 6.3mm for external aircon units. SCBH/vh Page 5 Simon Hunt Strategic Services SHSS.com

6 For aircons the trend is towards using Al tubes for cheap aircons and where copper I retained for reducing diameter down to 5mm (this is becoming standard in Japan) and perhaps eventually to 4mm. Wire rod production should fall by some 15% this year despite the massive increase in capacity over the coming two years. This increase is truly frightening. For foreign wire rod machines like Southwire and Contirod units, capacity was 3.4Mts at the end of It will be close to 9Mts at the end of Conversion prices will plummet next year, hopefully then forcing the closure of the weaker companies, a development which will probably form part of the new leadership s policy. We continue to believe that actual refined consumption will be down between 8-9% this year despite having to tweak some of our numbers. Stocks of cathode remain very large. One friend visited a large bonded warehouse in Shanghai recently concluding that there was around 600kt of cathode, several thousand tonnes of nickel and hundreds of tonnes of cobalt in that one warehouse. One reliable source indicated that stocks in bonded warehouses were 1.2MT, a figure with which we would not disagree. Based on our information, there are also very large stocks held in private sector warehouses outside the reporting system in China. When LME warehouses are opened in China, these stocks are likely to come into the reporting system. Jinchuan Group will be increasing its cathode capacity from 600kt/a to 1M/a next year. As to prices we make the following brief comments. 1 st qtr 2013 will experience weak global equity markets; commodity prices will then fall in sympathy. Copper should fall to about $6500 in the 1 st qtr. What happens thereafter depends on how Washington resolves or does not the fiscal cliff. Should there be little or no real immediate cuts in spending the US dollar will start collapsing in the second quarter. All asset values will rise sharply for 9-12 months. Under this scenario copper risks hitting a new all-time high but then start collapsing in Should Washington knuckle down and meaningfully cut spending immediately, the US dollar will rise sharply, asset prices will fall and metal prices will start their secular collapse. Either way we maintain our forecast that by the end of 2014 copper prices will be below $1500. For our reasoning please read our last large copper report with an outlook to SCBH/vh Page 6 Simon Hunt Strategic Services SHSS.com