…we have constructed a Chinese metals demand indicator based on the average z-scores of year-over-year changes for 25 metals-specific Chinese flow indicators. We have selected the data to represent the broad base metals complex and have included real estate indicators (e.g., residential starts, real estate FAI), construction indicators (e.g., output of crude steel, rebar, cement), power/grid specific flows (e.g., output of power cable, transformers, AC motors, power production), auto and white goods production (e.g., air conditioners, washing machines, refrigerators), and the production of first-use downstream products that are heavily exported (e.g., stainless steel, galvanized sheet, aluminum products).
The results of this analysis (shown in Exhibit 21) show that the aggregate Chinese metals demand indicator rapidly declined from 2Q14, reaching a low in 2Q15 not eclipsed since the depth of the Global Financial Crisis in 4Q08. While the indicator marginally improved in 3Q15, it remains very weak and below -1.00, meaning that on average the indicators we track are more than one standard deviation below their respective historical means. Moreover, unlike in 2008/2009 when the indicator quickly rebounded after dipping below -1.00 to a less extreme, yet still negative, average z-score of -0.68 the following quarter, the index has stayed low for two consecutive quarters and the outlook for further growth in 4Q15 and beyond remains muted…
To this end, our forecast for Chinese metals demand next year is largely shaped by 1) relatively gentle growth outlooks for some major metals-intensive industries considering the low 2015 base and 2) elevated levels of finished inventories that will likely have to be worked through before fresh demand lifts metals consumption. Regarding housing, while JPM equity analysts expect 5% growth in housing starts next year, the outright level of starts would still be below 2014 and more than 20% below the 2013 peak. Furthermore, inventory of housing supply in China has remained elevated at more than one and a half years’ worth of sales throughout 2015 (regardless of whether one calculates with 
completions or our analyst’s preferred metric of new housing supply based on a time lag in starts), quite a sizable backlog to work through (Exhibit 22). Similarly, in passenger vehicles, while J.P. Morgan equity analysts forecast 8% growth in sales next year, inventories of automobiles at dealers was 1.4 months of sales in September, just below the 1.5 months level generally regarded as an “alert” for high stocks that will need to be worked through. This raises the risk that production of passenger vehicles remains subdued even if sales pick up in 2016 as dealers will want to first reduce their level of inventory. Moreover, while other white good inventory levels remain relatively opaque, we believe air conditioner inventories in China likely remain near 20 million units, or more than 3.5 million units higher than year-ago levels (Exhibit 23). In conclusion, not only is the forecasted recovery in the main end use markets for Chinese metals demand likely going to be fragile while also moving off a low base year, large levels of inventory only add greater risk that growth might disappoint.
…In sum, even as base metals are trading at levels not realized since the Global Financial Crisis, we believe any sort of “mean reversion” in metals pricing next year will be delayed as still lower prices are needed to firm the fundamental picture. As such, we remain bearish on all the base metals we cover as we head into the seasonally weakest first quarter.
If anything, too bullish.
