Can China help bail out the global economy? (October 10, 2008)

If you think China’s super-hot economy and the astounding growth rates it has posted over the last decade will help buffer the rest of the world from the economic meltdown, you might want to think again.

China is not immune to this crisis and if you want proof look no further than the website of Mount Gibson Iron (MGX-A), an Australian iron ore producer.

In an Oct. 9 letter to the Australian Stock Exchange, Mt. Gibson’s managing director, Luke Tonkin, said the company had received requests from a number of customers in China to delay hematite ore shipments scheduled for the second quarter of the financial year.

“Customer and iron ore sector analysis indicates a slowdown in demand for iron ore in China due to current economic uncertainty and the tightening of credit facilities, leading to reductions in steel production and the current significant buildup of iron ore stockpiles at Chinese ports,” Tonkin wrote.

One measure of just how bad it is getting out there for commodities is the Baltic Dry Bulk Indexwhich measures shipping rates for dry bulk carriers on forty different routes.

According to Dow Jones Newswires, the Baltic Exchange’s Dry Bulk Index fell on Oct. 9 to its lowest level in 28 months on worries of a recession in the West and expansive iron ore inventories in China.

“I don’t know what Canadian mining companies are telling you but demand has really collapsed in China and India,” says a seasoned Singapore-based journalist who has covered Asian business for more than two decades.

The journalist, who requested anonymity, noted that last year China’s GDP growth came in at a sizzling 12%. But that rate is expected to fall to 9% this year when revised numbers come out in February.

“There is no shortage of economists predicting 7% to 8% growth in China next year,” he points out. “That’s a helluva come down from 12%. And India is even worse.”

Recent reports from Citi Investment Research, a division of Citigroup Global Markets, don’t seem to offset the prevailing gloom.

In a research note to clients on Oct. 9, analysts Thomas Wrigglesworth and Catherine Wang forecast a sharp drop in coal consumption growth to just 2.8% for 2009, down from 10.9% in 2008.

“We continue to think that energy consumption will be positive in the long-term, but a cooling period looks very real,” they warned.

The analysts predict a 5% increase in 2009 contracts, down from their earlier forecast of a 10% increase, and see spot prices plunging 30% quarter-on-quarter in the fourth quarter of this year.

Next year, they anticipate a 4% year-on-year decline in spot prices for coal, a 15% drop from their previous estimate. For 2010, they are lowering their estimate on prices by 24%.

One worrying sign they point to is inventory that has grown by 50% since June 2008 at Qinhuangdao, the chief sea port on Hebei province, 300 km east of Beijing. Inventories there have reached 8.7 million tonnes, 55% above the average since 2005. The port’s total capacity is 10 million tonnes.

For all Chinese ports, iron ore inventories amounted to 70 million tonnes, according to Citi, noting that “normal stocks” are around 30 million tonnes. The additional 40 million tonnes in stock represents about 3 weeks consumption.

Citi is also forecasting that the industrial component of coal demand will contract 5% next year as steel producers shut capacity.

Crude steel production growth in China slowed to 2.4% year-on-year in August, down from 8.8% in July. No doubt part of the slowdown was a result of the hiatus during the Olympic Games, but no one knows to what extent the Games curtailed steel production in the rest of the country.

Citi anticipates that Chinese crude steel production growth will expand 8% in 2009 and 18% in 2010, down from the trend of 22% growth over the last five years.

In a Sept. 29 report, also from Citi Investment Research, analysts Alan Heap and Alex Tonks said that they did not expect a huge fiscal stimulus in China with an emphasis on infrastructure.

“The domestic economy is slowing and the infrastructure build out will continue,” they noted. “Indeed in the fourth quarter earthquake repairs and a resumption in projects will see a reacceleration ofactivity, but it not be boosted by a major skew in government policy towards growth and fixed asset investment as we previously expected.”

They note that housing accounts for about 20% of China’s fixed-asset investment (FAI) and more than 20% of China’s total banking credit. They predict that FAI in the year to date of 27% will likely slow to 20% next year if the residential housing market slows.

Demand for other commodities in China may also ease next year. Citi notes that aluminum production in China has grown 12.3% so far this year, versus the bank’s previous forecast of 19%.

And while underlying demand for copper in China “remains robust,” Citi notes, “large inventory swings cloud the picture.”

“Shipment of copper semi-manufactured products continue at a robust 20% per year, but double counting and other problems make this data difficult to interpret,” the report states.

“Anecdotal comments from fabricators indicate that domestic demand remains quite buoyant although export orders continue to fall, demand for air conditioners is slowing, reducing demand for tube.”