COLUMN-The definition of being bullish on China is changing: Clyde Russell

06/27/2013

--Clyde Russell is a Reuters market analyst. The views expressed are his own.--

By Clyde Russell

HONG KONG, June 27 (Reuters) - It was hard to find anybody who didn't profess to be bullish about the outlook for China's commodity demand at LME Week Asia, but what is changing is exactly what market insiders mean when they express optimism.

The first major shift in thinking among participants at the metal industry's gathering this week in Hong Kong is that it appears that they are bullish about volumes, but not necessarily about prices.

The boom in China's commodity imports in the past decade was accompanied by a surge in prices, but it appears the market is finally coming to terms with the fact that this nexus has broken down.

Take iron ore and steel for instance. It's not an unreasonable forecast to believe that China's demand for iron ore imports will rise from 745 million tonnes in 2012 to a figure closer to 1 billion tonnes over the next 10 years.

Demand for the steel-making ingredient will be driven by China's ongoing urbanisation and the infrastructure building associated with this process.

Jun Ma, Deutsche Bank's chief economist for greater China, told the conference that he expected China's rail network to expand by 60 percent in the next eight years, while the subway system needs to expand fourfold over the same time period.

On the surface this type of forecast is bullish for iron ore and steel demand, and Ma's overall optimism appears to be shared by many industry insiders.

But ask about the outlook for iron ore prices and a different story emerges.

Just as finding somebody bullish on demand was easy, finding somebody equally bullish on prices at the LME Week Asia conference was a far harder ask.

Over the short term the expectation was for commodity prices to struggle until there is evidence that China's economy is starting to regain the momentum it seems to have lost in the second quarter of this year.

Over the medium to long term, the pricing outlook remains just as uncertain, with few industry participants willing to say iron ore will rise much from the current Asian spot price of $113.80 in real terms.

In fact, it was much easier to find forecasts for prices to fall to around the $90 a tonne mark over the longer term.

So, unlike the first part of the Chinese-led commodity boom, it's possible to be simultaneously bullish on demand and bearish on prices.

FUNDAMENTALS TO THE FORE?

Ultimately this is about supply-demand fundamentals re-asserting themselves in the commodity markets.

It's no secret that global supplies of major commodities such as iron ore and copper has been rising, and will continue to increase, in response to the Chinese demand story.

The judgment of the market is increasingly that the global miners such as BHP Billiton, Rio Tinto and Vale, as well as numerous smaller competitors, have over-invested in new capacity.

So while iron ore demand will rise, the new supply will overwhelm the extra consumption.

The same story is repeated for copper, where the market is expected to move to a surplus this year and remain in this condition for years to come.

This new reality is changing the way commodity markets work, with producers battling to get themselves as low as possible on the cost of production curve and traders increasingly finding that the easy money has long gone.

This makes it more likely that commodity prices will increasingly trade in line with the latest economic data, moving up and down in response to short-term news and swings in sentiment.

Iron ore's recent moves largely confirm this. While Chinese imports have remained robust, and at 322 million tonnes in the first five months of the year are on track for a 3.7 percent gain in 2013, the price has been falling.

May imports were the second-highest on record, but the increase in demand hasn't translated to an increase in prices, as the market focuses more on economic data that suggests industrial output is losing momentum.

The other realisation expressed by market participants is that picking winners and losers in the commodity complex has become much more difficult.

Will copper perform better than steel on the basis that manufacturing is likely to rebound quicker than infrastructure spending in China?

Will aluminium outperform steel as vehicle manufacturers turn to the lightweight metal in order to build more fuel-efficient vehicles, and will the steel industry stand idly by and let this happen?

Will natural gas imports via pipeline and liquefied natural gas be a better market than coal on the basis that China is going to get serious about cutting pollution and is prepared to pay for a more expensive, but cleaner, fuel?

The certainty around the China commodity story that prevailed up to the 2008 global financial crisis, and which was briefly resurrected by the massive stimulus spending post the recession, has been replaced by a raft of uncertainties.

So when commodity market participants say they remain bullish on China, it's worth asking them what that actually means as the definitions are shifting.



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