Monday, March 22, 2010

"Is China on the verge of a commodities unwind?" (FCX; RTP; SCCO; PLTM)

On March 16 we posted "Commodities: They Just Rang a Bell at the Top "ETF First From First Trust: Platinum, Copper Miner ETFs" (FCX; RTP; SCCO)".
Two days later platinum hit $1638 and copper $3.4048. Here's the 30-day platinum chart from Kitco:

Spot platinum is trading at $1581, down $24 today. Copper futures are at $332.65.
One more piece of the puzzele from FT Alphaville:

The debate over China’s prospective inflationary path continues to intensify, with worries mostly focused on the effects of a loose lending policy and the dispersion of capital spending.

One area that potentially counters such talk, however, is the lingering effect of industrial overcapacity in key Chinese sectors.

RBC Capital Markets’ emerging markets team looks at the issue on Monday, noting that while overcapacity was generally seen as a manageable concern before the global downturn — industrial production was steadily recording a 15-20 per cent year-on-year growth rate from 2004 to 2007 — things changed significantly following the crisis.

That’s a fact that should not be dismissed by China inflationistas, say the RBC analysts.

From 2008 industrial production growth figures in the Middle Kingdom fell off the proverbial cliff, and are only just now returning to pre-crisis levels:

As RBC notes, that 2008/2009 reduction in industrial production has inevitably lowered the need for investment requirements in the manufacturing sector on a fairly large scale.

The overcapacity risk, however, is most likely specific to commodity-based industries.

As RBC notes, the Chinese State Council in January identified electricity, coal, coke, ferroalloy, calcium carbide, iron and steel, non-ferrous metals, construction materials and light industry and textile industries as particularly vulnerable — with the steel sector seen as especially exposed....

The gravest concern, though, remains overcapacity’s effect on commodity prices if demand fails to pick-up sufficiently in the medium term, say the analysts.

For example, strong anecdotal and circumstantial evidence points to commodities having been a key destination for last year’s lending surge. Shanghai copper inventories, if you look at the chart below, clearly rose in the months following the spike in bank lending growth :

And, of course, the chart’s recent divergence is striking — mostly down to Beijing’s recent attempts to pull-in bank lending.

The critical factor therefore will lie in whether the divergence will soon correct.

According to RBC’s analysts there is a real risk that it will because China’s commodity stockpilers will undoubtedly now be under great pressure to sell speculative holdings — especially in the face of yuan appreciation.

If they do, the effects could be significant, and that’s not just for China (our emphasis):

We see a strong chance that speculators will be forced to unwind these positions. Authorities have already taken steps to direct credit away from speculative activities, and it is likely that investors that have relied on short-term financing to fund their purchase and holding of commodities will see their loans called in. If, as we expect, interest rates increase over 2010, this will exacerbate the problem. Such investors will also typically have borrowed in CNY to purchase commodities priced in USD, and so will be exposed to further losses should, as we also expect, CNY appreciates against USD as that will lower the CNY-value of the stockpiled commodities.

Commodity speculators who have relied on easy credit seem highly vulnerable to being forced to offload their holdings as conditions tighten over 2010. Beijing has also increased its sovereign holdings of commodities over the last 12 months and will be exposed to any price declines that may result. This also represents a significant downside risk for commodity producers and exporters....MORE